as Shane says, you’d be better off working in an app that can handle the native camera formats,
Premiere, or FCPX
(you can use your current Compressor to make the DVDs)
FCP7 really requires you to work with ProRes,
and your LT is as small as you can get without losing quality.
you could try down-scaling your rushes as you transcode to Pro res.
that’ll take longer, and wouldn’t be wise, i’d say.
it’s smart to be HD “future” proof (“now” proof, really!)
Down-scalng on transcode would take longer, too,
especially for the best results.
you can test it, of course.
you could try an “off-line / on-line” process, where you work with a smaller file size while you edit,
then either reconnect to or recapture higher res versions,
but really it’s a pain!
you don’t want to do it.
it would take a lot longer, and is just not needed these days
PERFORMANCE
2 streams of LT should be very do-able, what sort of drives are you using?
FW800 should be do-able,
but USB3 or Thunderbolt would be better.
cheers,
nick