Switching to metacity before connecting the second monitor works for me.
Interestingly, I can enable compiz with the second monitor connected,
the output produced by it is as follows:

Checking for Xgl: not present. 
xset q doesn't reveal the location of the log file. Using fallback 
/var/log/Xorg.0.log 
Detected PCI ID for VGA: 
Checking for texture_from_pixmap: present. 
Checking for non power of two support: present. 
Checking for Composite extension: present. 
Checking screen 1Comparing resolution (1024x768) to maximum 3D texture size 
(2048): Passed.
Checking for Software Rasterizer: Not present. 
Checking for nVidia: not present. 
Checking for FBConfig: present. 
Checking for Xgl: not present. 
WARNING: Application calling GLX 1.3 function "glXCreatePixmap" when GLX 1.3 is 
not supported!  This is an application bug!
WARNING: Application calling GLX 1.3 function "glXDestroyPixmap" when GLX 1.3 
is not supported!  This is an application bug!
/usr/bin/compiz.real (video) - Warn: No 8 bit GLX pixmap format, disabling YV12 
image format

-- 
[i945gm] [karmic] X servers hangs when settings up dual monitor config
https://bugs.launchpad.net/bugs/438000
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