Gator, sorry about the "....speakers?" joke; I just couldn't resist!
The idea is to prevent "early reflections." What that means is you should place sound-absorbant materials where, if your walls were mirrors, you would be able to see your front speakers with only one reflection.
Most home-theater speakers, especially THX-approved, have limited vertical dispersion, so ceiling treatment is usually not needed. However, many people feel that, because speakers are usually floor-standing, or nearer the floor, carpeting is recommended.
Since the desired "ambiance" and surround effects are recorded into the soundtrack, the listening room should be 'eliminated from the equation'. That's the idea behing wall treatments.
On the other hand, two-channel stereo usually sounds better with room reflections allowed. There is an exception to this that is referred to as "LEDE", which means Live End / Dead End. That means one-half of the room (usually the 'front') is treated to reduce reflections, while the other end is allowed to provide more bounce.
When you foamed the entire room, you created an anechoic chamber. Most speaker systems are tested and measured in such chambers, because, as you found out, the effects of reflection are almost entirely removed from the sound.
With enough power, you could have returned most of the missing volume, but the sound probably seemed unnatural. By the way, know where absorbed sound energy goes? It's converted to heat by friction in the absorbant material.
Larry
www.fineelectricco.com