This may be cold, but IMHO, this is only an issue for people who don't have HDMI. Almost every HD capable device offers a builtin scaler, the TV/Projector, the A/V Receiver/switcher, etc. In older sets they tended to suck, but in newer sets, quality commodity scalers are common. The Xbox360 doesn't have access to scaler chips any better than manufacturers who built sets today. The reality is, except in speciality cases like high-end videophile units (ala iScanHD DVDO), the scaling is pretty much the same -- yes, scaling digital data is not a black art. (the horror that was upscaling in most early HD sets was mostly encountered in dealing with 480i->720p/1080i and cadence issues)
The question is what to do with people who have non-flat screen analog tube sets, the kind of people who mistakenly believe that they have a real HDTV (nope, none of these old sets can really display 1920x1080i, sure, they can accept the single, but the CRT they use can't deliver anywhere near that resolution, just go read up on the measured resolution of top-end CRT HDTVs on AVSForum)
There are two solutions: 1) burn extra PS3 RAM for a larger front buffer (when not in render-to-texture mode) or 2) require them to use an external scaler.
Franky, if I was Sony, I'd sell these people a DVI->Component dongle with builtin commodity scaler. Unlike the case of the XBOX360, which, IMHO, completely fubar'ed their design by not providng a way to get digital framebuffer data out the AV multiport (hence, no DVI), Sony is in a better position. The HDMI port provides a possible "out" for them. There are in fact, plenty of HDMI/DVI->Component/VGA converters out there today, sold to help people with older sets, but in reality, used to strip away HDCP. (I should know, I own one which I use in pass-thru mode to strip HDCP for my non-HDCP projector, instead of using the analog-out) They are price today, but that's because they are mostly made by small market players, not mass produced, and there is low demand. Sony however could probably significantly cost reduce such a dongle, especially with a custom design.
If they were smart, they'd take the MS approach, like MS did with HDMI. Remain silent, leave things a mystery as to what they're going to do, while saying a "solution is coming", and then selling their dongle later. I don't like reserving extra RAM just so people with geriatric and make-believe HD CRT sets can get their flickery 1080i fix. It burdens everyone else, both 480p SD users, and those with HDMI capable sets.
Most of the PS3s that will be sold will probably be sold to early adopters anyway. Some are being sold in bundles that require buying a new HDTV. I really hope Sony doesn't waste 3-6% of PS3 VRAM on a solution that can be rectified in the future by HW.