pdls,
MCE 2005 (XP based) certainly does work, and very well. Hopefully Vista will be even better.
The 360 should do pretty much what you want it to. It connects to MCE using a remote terminal connection, and displays pretty much the same MCE interface as you see on your PC on your TV. This provides functionality for viewing photos, listening to music, watching TV, scheduling programs, watching DVD and video, etc. Almost everything that you can do in the MCE interface on the main PC, you can do through the 360.
However, you are limited to only being able to use the MCE software through the 360, so you can't run Word, or Internet Explorer, or even WMP from the 360 (although you can use various plug-in applications that can provide additional functionality).
Without any additional software, the 360 probably won't be able to play your video clips, as it's very restrictive about the formats. The good news though is that there is a program, "transcode360" (google it), which can allow a 360 to stream most video formats from the MCE box.
The resolution problem isn't really an issue when running through the 360. You just set the TV Display properties, and all output from it (games, MCE interface, TV) uses that resolution, so there's no fiddling around at all. I use it on a 36" CRT, and it looks fine from the sofa.
Balders.