The most sensible reason I can see for doing the conversion in the DVD Player/Console or whatever is that they can use the flags in the bitstream to remove the guess work about which fields go together. MPEG2 and the more recent standards have (optional) flags specifically labelling fields that go together to make progressive frames. In the TV none of this information is avaialble so they use image analysis to guess. On occasion they get it wrong (particularly around edits/cut scenes) so the motion looks jerky.
Cost restrictions on consumer TVs obviously limits how much image analysis they can do in real time.
Yes, that was my conclusion earlier. IMHO it makes the most sense to simply encode the original progressive content, then add standard 2:3 telecine flags for playback, because most TV's can detect that and it is losslessly reversible. AFAIK most movies are encoded in this way (though other video content often must be encoded differently). Does anyone know if all HD-DVD and Blu-Ray movies are created in this basic way?