Has there been any further investigation of smarth (http://smarth.sourceforge.net) since your original post?
I realize that the long-term goal is to have an equation editor cleanly integrated with Moodle. But to paraphrase your remark from 2005, "What, 2007 and STILL no equation editor?"
As an interim solution, Smarth could be integrated with Moodle in a very loose fashion, relying on smarth's ability to output LaTeX. The student would do the work in smarth, then copy the LaTeX from smarth and paste it into a Moodle text box (in a quiz or online assignment). It's not perfect, but it's better than nothing! See this discussion.