Setting default values for System Configuration fields is well understood (via Chapagain and blog post from @alan storm) but password fields are different because they are encrypted when saved to the database. Hence when Magento reads the default value from the config.xml, it tries to decrypt the value and fails if the default is in plaintext.
Is there an XML helper or process (other than creating a setup script to with $setup->setConfigData('config/path/here', md5('default')) ) to specify these defaults?
It’s an interesting question / thought experiment, but the current behavior seems reasonable. If data storage for a value requires encryption, I can’t imagine it being appropriate for a functional value to be present in plain text anywhere in the filesystem, whether in config.xml or in an install/upgrade script.
The only other option, encrypting it yourself, is likely undesirable, as you would have to be hand out and therefore be aware of the crypt key value.