I'm probably not the best suited to "defend" the practice since I 1) Don't go there, and 2) Largely agree with you. I just wanted to make folks aware of its existence given it gets at the point that one can be a PhD student without having an MA.
I am a bit confused by your post though, since you pose the question of "Why have a project" and then go on to delineate exactly why they should do a project. My understanding of it when I interviewed was that they retained most of experiences involved in a master's, but did not award a degree for it. The point was just that if a school doesn't award a master's, one would pretty much have to be "PhD in progress" per the above the discussion - though I agree "candidate" should not be used.
I agree with watering down - it seems the system has become more about getting people in and out quickly while building a "CV" rather than building actual qualifications (i.e. abilities). I'm not suggesting a return to a few decades past when many programs expected people to stick around for 9-10 years, but I do think its gotten pushed much too far in the other direction, with people cutting corners on theses/dissertations/etc. rather than doing more substantive projects where they would likely learn more. (I realize you got out fast, but it also sounds like you worked faaarrr more than average to achieve it).
Psyman - Sorry if you find that obnoxious, but I'm not sure why. I'm on a hardcore research path, what possible reason would I have to consider PsyD programs? Even the respected PsyD programs are certainly not in the same league of research-emphasis and research training opportunities as clinical science programs.