Unfortunately, there's nothing "wrong". In order for video to be slowed down, extra frames must be generated. Vegas does this by blending the video of two adjacent frames together to make a new intervening frame. If you slow down the video by a small amount, it's not too bad, but the slower you go, the worse it gets (much like slowing down audio - which can cause distortion when used to an extreme.)

If you want GOOD slow motion from DV, then you should try Motion Perfect. This stuff is the bomb. Check out the samples and you'll see what I mean. You can slow video down to half or even quarter speed. You can email me at originaltrilogy at yahoo dot com if you have any questions about it.