I tend to believe that trainsets around christmas trees became popular due to the relative cost of a trainset. It would have been a major Christmas gift, and very likely would have been assembled around the tree rather than packaged up. The kid would come running into the living room on Christmas morning and see a brand new trainset around the tree. I remember when I was 4 and found an LGB diesel at the base of my tree. It would be a very memorable Christmas, and it would probably get set up again in subsequent years.
As a little kid, I always loved setting my LGB up around anything it could run around...the couch was second only to the christmas tree. I always would get excited about the Christmas tree, in part, because it would be set up for a month.
Trainsets are not for those of us who are experienced modelers (or most adults looking to get into the hobby), would probably be the worst way to get into the hobby. The powerpacks are of limited value, the cars are usually cheapie 1970s cars (with cheapie locomotives that don't really go with them), and the track is that infernal integrated roadbed stuff that costs a ton of green for expansion (but nice for people without layouts). Lionel made toy trains, not models. That is exactly what trainsets target. Most Lionel people I know are Lionel people for the same reason that some of my friends are into Legos, GI Joes, and other toys. (some of the newer Lionel stuff is definitely not toy train stuff). Little kids could care less about prototypical details (how about an NYC 2-6-4 anyone?), but having a missle launcher car is pretty cool. That was Lionel. Further, they'd stand up a little better than the HO of the day (or today). Frankly, I don't think it compares well to large scale stuff today (LGB, Bachmann Big Haulers, and such). The prices are comparable, but the larger stuff will survive even better, is larger for hauling presents, and is the proper size for GI Joes/action figures...and my kid will not have Lionel. Still, Lionel has become a well run company, and certainly both their Harry Potter and Polar Express sets are quite popular.