First of all, I am a long time user, love FWP, could not live without it:-)
But I must say I am now quite shocked to see what I thought was a bug is actually a decision you've made .. perhaps my use case is very different from the majority (I don't auto-publish, manually edit everything), but I think it is a dramatic choice, and a bad one. I can't edit posts in a text-only environment.
Of course before reading this thread, I ahad no clue what the reason was, all I saw that visual editor disappeared after the WP 3.5 upgrade. It took a while to figure out it was caused by FWP. So now my solution is to downgrade back to the previous FWP release, which allows use of WP visual editor.
Now, to the core of the story: I've always (for years) had the "expose to formatting filters" setting on, can't remember what the reason was, just that I had better results that way. Even then, some posts show up with line breaks stripped out - but that's just 2-3 of my 50+ source feeds. Still, I can deal with those better than losing Visual Editor.
I'll try your fix on a test site, but until then I'll leave my productive FWP at the previous release.
Thanks a lot!