Who cares if you don't have Bay Area engineers? Their ability isn't based on where they live, is it? If they want to lower their costs of living so they can compete they can "just move".
Which makes the point: why would a company pay such a premium on hiring from a single location if, in the end, it can only get the best engineers from there if it pays an even higher premium than the ridiculous salaries from the place? It doesn't make much financial sense, seems to be mostly based on "feelings" during hiring, like yours.
Silicon Valley has a local bubble economy. If overpaid engineers spend their money for overpriced health insurance, rent, mortgage or juiceros the boat stays afloat.
But if the SV companies start sending money abroad the bubble would deflate...
Most engineers seem to life in SF out of necessity, more than anything else. After all, that is where most jobs are.