When you put text in to the editor area, if you click the 'source' button on the editor tool bar, can you see formatting being applied in the html code?
Also, regarding the line spacing, - in your fckeditor/fckconfig.js file at or near line 122, what value does FCKConfig.EnterMode have?
It should ideally be:
FCKConfig.EnterMode = 'p' ; // p | div | br
That should enter a normal paragraph return, and add <p></p> tags to the text entered.