You make HD settings for the games in the MS Dash menu, like you did. You could pick out a game that actually supports 1080i or 720p to test. I have a link in my sig that will point you to some.
Other than that, most games support widescreen in 480i and 480p. Remember that 2D graphics (text and HUDs and scores) will often look stretched but the 3D models (i.e. cars, your player, enemies, etc.) should look correct. Find a circular object like a wheel and see if it is oval or circular.
On your TV in 480i or 480p you may have to enable a "wide" mode like when playing back an anamorphic widescreen DVD, but you shouldn't need to use any "stretch" modes.