This matches my problem to a T. Including the static screen with the ships clear as day while everything is going haywire as well. That always struck me as odd. I was in an online chat with Xbox Support and he thought it could be a cable issue. I wonder if there is anyway to get a 1st gen 360 to export through a traditional HDMI cable and not an HD component cable? Anyone know?
I have a friend who is running a 1st Gen 360, has the same make and model TV, same make and model router and DOES NOT have the issue. He even brought his disk over to run on mine and we ran into the issue. So it isn't disk related.
The optimizing HD Content everytime is what strikes me as oddest. It's like the game sense something is wrong or corrupt and is trying to correct it. Having only "in-game" stuff be all wonky, and not the Xbox Dashboard or anything else outside the game not be all pixelated leads me to hope it can be fixed with that patch that was promised a week ago.
I am beginning to see a pattern that most people that have this issue are running 1st Gen 360s. So that's fun. It's probably part of a bigger conspiracy to get us to buy an XboxOne. Ha! (cries inside)