I still don't see the AH as the direct problem, but as-is it's certainly the largest, most irritable symptom. The problem is a large shift in focus from D2's character-centric gameplay to D3's gear-centric focus. D2 had you looking for gear that accentuated the way you wanted to play a character. D3 has you looking for gear... to look for gear. You don't have the option to "go for a [insert variant] set" because there are no variants.
I'd propose adding in more methods to customize gear, that give SOME control to the player besides "this is all crap. Need to farm more gold for less crappy crap." If there were some way to, for example, put half an item's stat budget on the item as a stat of player choice (but that still cost the player something. Worthless crafting mats, perhaps?), the massive piles of shit would have some use other than vendoring, and almost-but-not-quite gear would still be worth something to the right person.
That would all need to be worked into a class rebalance and more useful/varied item mods though. If something besides main stat, vit, allres gear was appealing, the market might dilute to a more sensible place.
However, given their history of axing content that gave players options (blacksmith socketing gear, the mystic enchanting gear, magic weapon damage effects), I fully expect their solutions to be turd sandwiches. If they pleasantly surprise me, it'll be the first time since Ulduar. And that was a while ago.