As good as it is, there are still numerous variations of AVIs that Vegas can’t, for a wide variety of reasons, can’t read.
Just ask anyone who’s tried to load an “AVI” from a digital still camera. Turns out it’s actually an MJPEG codec that you need to install to be able to read it properly in Vegas.
Edward mentioned the File – Import – DVD Camcorder Disc option and, in your situation, that’s what I would use.
I’ve done this numerous times and it works well.
Another good reason for doing it this way is that you avoid another stage of de-compression/re-compression and, as you’ve discovered, doing what you’re doing can knock your quality level down, in some cases a lot.