The best solution is to use a hardware MPEG video card… that way when you capture the video you have fewer recompression steps and the source video doesn’t take up a lot of space.
If you are using the video in port of your video card, then your best bet is to use IUVCR or VirtualDub. You will have to install the video and audio codecs indepentantly and configure the software to use them.
If you try to capture using any codec other than the MJPEG codec, you’ll probably skip frames: even with today’s fast processors. MJPEG files are huge, too (like 1GB per minute or so). Once you capture the source file, then you must edit it and compress it.
It is a lot of work/trial-and-error when using software for non-accelerated capture. Hardware cards make capturing video so much easier, too (don’t have to guess the audio input and video input settings) I’d use a hardware mpeg board (especially if you’re going to be making a lot of video). Then use Womble MPEG VCR to edit it (it is a VERY fast frame-accurate MPEG editor). If you have no other processing steps, then just run it through your favorite video compressor (Divx, Windows Media, etc).
Basically just hook up your console using S-video or RCA jacks (sorry, HDTV capture isn’t possible yet). Make sure you turn time-shifting OFF (else you will have a 1-2 second delay between when you move the controller and when the character responds). Play the game and get your raw footage. If you have interesting scenes of note, load up your save points and play from there until you get enough raw footage.