The problem lies in the original AVI, most/many off Morpheus are not encoded at a high enough bit rate and further conversion to VCD creates the blockyness you are seeing.
If the AVI is in widescreen format, dont try and expand it out to full screen by chopping off left and right sides, there is just not enough data in the picture to allow that to occur and get a good cleen final VCD. Leave it as is.
Also, in TMPGEnc, go to Settings/Quantize Matrix and tick on Soften Block Noise. For ALL AVI's I convert I tend to leave it at the 35 default setting, but for really bad ones move it up to 50 to 80 for exteme. It will get rid of most block noise but the picture will become softer or less sharp.


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