To just touch on this point again..

More important than the issue of the contractual obligations and moral hazard is the fact that the IOU's don't carry any information to the lender. (asset holder.)

It's not a feature of ripple that the tie between the lender and borrower is broken by a myriad of jumps, it's a defect.

It's a defect precisely for the reason described in my opening post. If you break the relationship between the lender and the borrower, then you have to try to derive the correct terms of the IOU at the final point from the relationships along consecutive users in the chain, which bears no relevance to the problem.

But maybe I'm getting too theoretical.

In markets today if you want to borrow money you have to go directly to to the lender and present your case. You have to tell them what the loan is for, what your experience is, how trustworthy you have been in the past (Credit rating), and what you can use to back your loan (Collateral).

Using this information, the lender decides the risk of the loan, and assigns an appropriate interest rate and length of the loan.

In Ripple, this doesn't take place. Instead, the borrower goes to his friend (who's standards are usually much lower than a bank.) then the friend goes to his friend and so forth.

How can you determine an appropriate interest rate and terms for the loan from unrelated relationships in a chain? You can't. All of the appropriate data that could be used to make the determination is washed away long before the request gets to the lender.

In this way, highly risky loans make their way to asset holders through Liquidity Providers without any warning or determination being made by the lender.

That's why the fact that IOU's are not literally passed to the lender does not solve the problem that I was talking about in the opening post.