H1-B system was broken
"Unless of course large US companies want to outsource to smaller US companies which build their staff mostly out of H1-B workers. But since large companies do this is order to get rid of staff, there should be plenty of local talent for these smaller companies to use instead of H1-B workers.
Or am I missing something?"
You're not missing a thing. The H1-B system was intended to allow hiring workers for positions where local workers are not available. For instance, I hear that nuclear reactor techs tend to be shipped over from Germany along with the reactors they are operating, because there are not locals trained in operation of these systems. Fair enough.
The problem is this system is widely and systematically abused. They will list a job with, say, 10 years experience in Windows 2008, C#, Fortran, Cobol, and System/360 assembly. They will reject anyone who says "no" to any of these (even the physically impossible 10 years experience with a 5 year old product), and call the person out for lying if they say "yes". This job can be listed for 1 day in tiny print in 1 town newspaper (possibly across the country from the town the job is actually in...); they don't really want people to apply, they want to show that qualified people *don't* apply. Several companies have been caught out red handed doing the impossible interviews and odd ads, but the fines never come. Then they will claim they couldn't find anyone, and go hire H1-Bs (who don't meet their requirements either of course but are willing to learn -- of course, most of the people applying were willing to learn.). This was initially done to force down wages below what locals would work for, but now is so ingrained that there are people willing to work for the lower wages (the economy is bad) and they STILL won't hire them, because they are used to hiring H1-Bs. There's large amounts of high quality IT and computer science talent sitting unused in the US because of this system.
I'm shocked (Well, not really, the US political system is broken and ineffective)... Anyway, I'm shocked that it took this long for the feds to do anything about this broken H1-B program but I'm glad they finally are. Hopefully it's effective.
I expect these Indian firms to be outraged -- they may charge the firm receiving H1-Bs a "finders fee" for finding them employees, and may ALSO charge the employees they supply a "finders fee" for finding the employees work -- it's a cash cow for them and it's at risk.