Unencrypted traffic through Tor is bad, but sometimes better than no Tor
"Onion routing actually exacerbates the risk of packet sniffing"
Sometimes, but not always. Tor protects against local sniffing, but permits exit nodes to do so. Allowing either is pretty bad, but without using Tor it means that someone snooping the wireless or staff at the local ISP can read their email.
In the case of an embassy, local sniffing could be particularly bad as they are, by definition, in a foreign country. Someone sitting outside an Internet cafe, reading what goes past could be very interested in foreign intelligence. Sending data through a random exit node is a risk, but in most cases they won't care about the traffic.
Clearly the solution is end-to-end encryption, and there's not much Tor can do about that. Whether Tor makes things better or worse is a complicated question and depends on the scenario. I discuss this more on my blog: http://www.lightbluetouchpaper.org/2007/09/10/embassy-email-accounts-breached-by-unencrypted-passwords/