Here's a proposal extension to the existing crafting and loot system. The idea is to use existing random loot as crafting components for making new items that could theoretically show up in the random loot tables.
In the crafting station in the market place, 5 components fit in at once. There is a "floating" "shard" component and four "loot" components. The "loot" components are: two "prefix" components, followed by two "suffix" components. While the order of these four is important, they can be broken up by the "shard" component.
The "shard" component uses Khyber Dragonshard Fragments. The quantity is equal to the minimum level of the item being created, squared. This "shard" component is considered a "floating" component because whatever component follows it will be used as the basis for material type and base bonus, for weapons/armor. For example, if the next component is mithril +2, then the output item will be mithril +2.
The "prefix" components must contain the same prefix power (such as +3 wisdom) and the "suffix" components must contain the same suffix power (such as +5 haggle). Each of the "prefix" and "suffix" components must have the same minimum level, and must be the same type of item (i.e. bracers, rapier, etc.).
So, what comes out is an item with the prefix of the "prefix" components, the material and base bonus of the component that followed the "shard" component, and the suffix of the "suffix" components.
** Note: I recommend that this doesn't work with named loot, only pure random loot. **
Let's see an example:
Inputs:
slot 1: +2 wounding dagger of righteousness (lvl 12)
slot 2: adamantine +3 wounding dagger (lvl 12)
slot 3: +3 icy burst dagger of puncturing (lvl 12)
slot 4: 256 Khyber Dragonshard Fragments
slot 5: alchemical silver +4 dagger of puncturing (lvl 12)
Outputs:
alchemical silver +4 wounding dagger of puncturing (lvl 16)
I would say that items beyond cap (currently 16) should fail to create without consuming the loot components. It may make sense to not allow loot components that are bound, or even those with racial restrictions that change the level maximums.
As an alternative to make things more expensive, the type of dragonshard could be changed, or vendors could sell something that fills that slot which costs a fair amount of gp.