Because grad schools produce more (graduating students) than they consume (hiring faculty).

Yes, that much is obvious. But you would think that if a department is staffed by, say, MIT graduates, that they can do MIT-quality research, thanks to their MIT training, without being in the geographical vicinity of downtown Cambridge. Despite this, academic status-signaling seems to assume that the geographical vicinity is of profound importance.

Those ex-MIT profs no longer have access to MIT-level resources and MIT-level grad students. The latter being more important than the former.

Not everyone mit graduate is MIT professor good.

That's possible, but when we know that many people who are MIT Professor Good could not get into MIT for undergrad[1], it still requires us to believe MIT's admissions and graduation criteria for PhD students are very loose compared to all their other observed standards.

[1] -- http://www.scottaaronson.com/blog/?p=2003

That's frankly ridiculous, or at least the CalTech example at the end. For undergraduate study, MIT and CalTech have a strong filtering function in that you must be able to do math and calculus based physics, and, oh yeah, one "humanities" course per term. A student brilliant only at math would likely fail horribly. And so a student who's brilliant at just CS might not make the cut for MIT, since MIT's EECS undergraduate program requires a minimum of both EE and CS (for better or worse, that's their view of what an undergraduate must have).

Change the domain to graduate programs and above and things are different.

While I'm at it, back some years ago last decade before MIT gained a lot of attention approximately 13,000 students applied a year for the undergraduate program. 3,000 were judged to "be able to do the work", and only from them was a class of 1,100 students constructed.

Because these universities produce more students than tenure-track positions?

They do that because their "better" colleagues from the top tier also get the jobs at the top tier. Note that "better" likely includes a healthy dose of luck.

Why can't everyone who joins the military attain the rank of colonel or higher eventually?

On the other hand, when you become an officer you'd have to be grossly ignorant not to know about the (US) military "up or out" policy. One complaint here that seems to be legit is that students are not told how poor their job prospects are in raw numbers. Now, some of that is no doubt to avoid discouragement, you don't know if X student will later shine, or burn out, but....

I got my degree in the early 90s. At that time, it was already common knowledge among grad students that we couldn't all be hired into academic jobs. How could we not have known? My dad, who got his PhD in the 50s told me it was well known even then.

That's an issue for academia in general. One gets the sense that during the boom times, the universities stopped caring about the job prospects of their graduates since they figured the degree would give them an advantage one way or another.