MPEG1? Such a strange format. It's likely there's a terrible mismatch of video specs and project settings -- but you haven't given us enough information to tell for sure.
What model of camcorder is this video from? Was it digitized through a device? What is the resolution of the video?
Which version of the program are you using on what operating system?
I agree with Ann. If you're going to convert the video, you need to convert it to a format and resolution Premiere Elements can actually work with. (Just because a file can be played -- even by the Organizer -- doesn't mean it can be edited.)
Although part of the challenge is that your video is 960x720, which is not a standard consumer video size. Is this video of a commercial Hollywood movie that you're ripping to a create your own video file?
That said, you can try using Handbrake to create an editable MP4. Set Handbrake up to output an 853x480 MP4 with a 30 fps Constant Framerate. This will create a file that will digest and edit smoothly in Premiere Elements.
Otherwise I'm not sure what to recommend. You're working with video that is highly non-standard. I'm not sure even a pro app would be able to edit it efficiently.
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