As has been suggested, I suspect it's the external USB disk. Most of them start their lives with FAT32 formatting, because everything under the sun will read and write from FAT32.
As far as the last big cat with Classic mode support, 10.4 is the way to go. If you have a nice high-end PowerPC laptop like the 1.67GHz G4, there's no reason to revert it to something lower (and honestly, it may have shipped with 10.4.something anyway.) In fact, if having an older PowerBook (such as any Titanium PowerBook) around for Mac OS 9 apps is a possibility, what I would suggest is that you use one machine (such as a TiBook) for Mac OS 9, and install Leopard/10.5 on the faster PowerBook. The only exception here is if performance is critical, but I've found that if you have an app that is noticeably faster on a 1.67GHz PowerBook than a 1.0, you should either find an OS X version of that app, or buy a faster OS 9 desktop, because it will not work very well in Classic Mode anyway.
(This may just be oddities with stuff I've tried, such as PageMaker 6.5, but in my experience, Classic Mode was great as a stop-gap, but very very bad as a long term solution.)
As far as the last big cat with Classic mode support, 10.4 is the way to go. If you have a nice high-end PowerPC laptop like the 1.67GHz G4, there's no reason to revert it to something lower (and honestly, it may have shipped with 10.4.something anyway.) In fact, if having an older PowerBook (such as any Titanium PowerBook) around for Mac OS 9 apps is a possibility, what I would suggest is that you use one machine (such as a TiBook) for Mac OS 9, and install Leopard/10.5 on the faster PowerBook. The only exception here is if performance is critical, but I've found that if you have an app that is noticeably faster on a 1.67GHz PowerBook than a 1.0, you should either find an OS X version of that app, or buy a faster OS 9 desktop, because it will not work very well in Classic Mode anyway.
(This may just be oddities with stuff I've tried, such as PageMaker 6.5, but in my experience, Classic Mode was great as a stop-gap, but very very bad as a long term solution.)