It is your responsibility to make sure any content you post, or allow to be posted, to a site under your DreamHost account is legal. If you "are not sure whether some of the content, ... is indeed illegal", it is extremely foolish to allow it to be posted. The best rule is very simple:
If you did not create it, or cannot prove that you have the legal right to publish it on your website, don't do it!
While that is not completely safe (you could create content that is an illegal derivative work, for example), it's a reasonable position to start from. You should always obtain legal advice before posting anything you are not sure of, unless you are willing to face the consequences should the content be determined to be improperly copied/used/published.
Sure, the web makes it easy for anybody to be a "publisher", but that "ease of production" doesn't relieve them of the responsibility of complying with intellectual property laws.
I don't see it as being "cruel" at all - it is "unpleasant", but it is often a necessary step for a web host to take to protect their own business interests.
If everybody got a "warning", there would be no reason for them not to take the attitude, "Hell, if they catch me, I'll just apologize and promise not to do it again, meh!". This could easily result in DreamHost staff spending all its time chasing down these violations.
With the possible exception of the whole "non-publicly accessible " backups discussed elsewhere in these forums, I think the TOS, and the Abuse Center statements are very clear. Those who post/publish questionable content should be well aware that "account termination" is a possibility if they have read the TOS at all. If they could not be bothered read it, and honestly don't know the risk of account termination for such things, their account should be terminated also, as they have proven they are not responsible enough to be trusted with an account on someone else's server.
Hey, I can empathize with the person who gets his/her account terminated, but I can't really feel sympathy for them; any way you look at it, at the end of the day, they did it to themselves. Yes, even if their "friend", client, Dad, Son, Cat, or pet turtle actually did it, it was their account and they are responsible for how it is used.