You sure the original AppleTV was 1080p? I had one, but back then my TV was only 720p anyway, so I have no idea if it went up to 1080p. The reason I doubt it was 1080p is that all the HD content on the iTunes store is 720p so why bother supporting 1080?
Yep it is 1080 got the options setting opened up on the TV right in front of me right now.
That was another little trick I didn't like about the new AppleTV: they took away the option to rent "regular" resolution movies or TV shows when ordering from the AppleTV. If you want to rent or buy a movie or TV show in regular definition (for a cheaper rate) you have to buy it on your computer and stream it to the new AppleTV. That comes off as just a sneaky way to trick people into paying more. If I'm forced to watch some chick flick with my girlfriend without any special effects or action or anything meaningful at all going on visually, it just adds insult to injury to also force me to pay a couple of extra bucks to watch it in hi def.
P.S. You may have hit on why they downgraded, but you can still use it for viewing pics, youtube vids, and other content in full 1080.