1. Muppet Babies hasn't been released on DVD, because all of the references in the show all have their own unique copyright. Yes, I am sure George Lucas would allow his Star Wars references to be used, as he was a personal friend of Team Henson (the fact that Frank Oz originally performed Yoda would prove as much), but all the other references--such as Wizard of Oz, Star Trek, The Jetsons, et al--would need proper copyright handling and all that.
References like Star Trek, Oz, and Jetsons, as they were used in the show, would fall under parody law. The only time Disney was skiddish about it is when they released the The Tick DVD's, and were afraid Marvel would sue them for the use of a parody character. Of course, at that time Disney and Marvel were in a dispute over the Saban produced Marvel shows (Spider-Man, Fantastic Four, etc) that Disney acquired when they bought ABC family.
But for the actual film footage of Star Wars, Indiana Jones, et Al, not to mention stuff that Columbia let them use (as they were in partnership with Henson at that time), then we'd have the problem. But I do feel, if they really wanted to release it on DVD, they could just go out of order, and start from the last season, or just do "Best Ofs", as they used little or no found footage in most of those episodes (and quite a few only used public domain stock Black and White Footage).
Question is at this point, do they even care to release them on DVD?
2. That show was a flop. It originally was going to be coupled with Muppet Babies (seeing as the familar closing theme is actually an instrumental version of that Monsters series), but because it failed so badly, it was scrapped and Muppet Babies was aired of its own accord.
I believe he was talking about
Scary Scary Monsters, a brief product idea that resulted in a bunch of kids books, and nothing much else. Not to be confused with what you're thinking about, Little Muppet Monsters (AKA Muppets, Babies, and Monsters). LMM was only a failure because Jim didn't think it was a good fit, and personally canned the show after 3 episodes.