The arguement was about character customization and people where calling oblivion's completely inferior when it was just as good as morrowind's and that doesn't have much to do graphics because you can have a version like oblivion's but with worse graphics.
1) character customization usually refers to your character's abilities, especially considering most ppl use the first-person view and barely ever actually see their character, and morrowind kicks the absolute [censored] out of oblivion on all fronts in that perspective
2) no you can't, bethesda spent almost every once of space on the disk for gameplay and maps, that's why there are so many loading screens while you run around morrowind because the disk barely has enough space to hold the map (especially if you have the GOTY edition which should have come with 2 disks but that's neither here nor there,) but when you load a disk with as much information as morrowind and a system like xbox that doesn't have nearly the amount of space required for graphics and gameplay that a 360 does, you sacrifice things like taking 50 difference hairstyles into 5 different hairstyles specific to race and gender, you keep the appearance of minute things like hair to a minimum so you can use the limited disk space to make the game worth while, they didn't have physical room or enough give a [censored] to make room for something like hairstyles, and no one is going to bother to load up a disk with something like aesthetics when, quite frankly, you don't see enough of your character for it to really matter, would it be nice if they had it? sure, does it really impact the game or your ability to create a truly great video game character? i sure don't think so