It seems that the watermark extender allows you to type into the textbox without the extender removing the watermark.

It also seems that this only happens in IE.

How to test:

Create a page with a Textbox and the watermark extender.

While browsing the page, set focus on the textbox, hit the refresh button, and after the page loaded, just type. You will notice that the type text is added to the watermark.

I've create a WorkItem on the codeplex. So, go there and vote.