Brian – I agree that liquidity is part of the problem with the lack of manufacturing and production…. but only a part. The other problem is lack of demand. When the housing bubble burst folks no longer felt as wealthy… so spending slowed. Add higher in employment than before the collapse and you have another factor killing off demand for those manufactured goods. The job market is just barely starting to recover.
As far as toxic assets eventually recovering… not so much with the mortgage backed securities. Foreclosures force a recognition of the loss. If enough houses foreclose that MBS will never be above water. The AIG credit default swaps paid off dollar for dollar to Goldman… those will never be anything but a loss.
