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Your screenshot actually looks very decent. An average DVD encode with almost no or very little downsizing (W-Zoom 95% to 98%) usually has a 688x288 frame size, or 744 16x16 blocks. In your case the frame size is 640x480 or 1200 16x16 blocks. It means that your 536kbps encode has the same quality as a 9/16 DVD encode at 332kbps! (744/1200x536). I don't think in this case you could expect miracles from your encode and maybe at such a low bitrate ffdshow simply does not trigger the deblocking part (not sure about it however), trying to preserve as much picture contrast as possible, otherwise you'll really get a blocking-free picture but so blurred out that no text would be readable. Just try the same encode at about 900-1000kbps and if the blocking persists this maybe really a bug that needs to be fixed.
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