Is Photoshop a raw processing tool?

Pretty much, yes. It has a RAW import feature where you have very granular control over things like color temperature and exposure. Picasa doesn't give the granular level of control but it can read the RAW file and allows you to manage/manipulate it and export the end result as a JPEG.

It is free and pretty easy to use. Give it a download and see how you like it before spending money on anything else. You don't have much to lose.

Photoshop Elements 7 has a plug-in Raw editor, which seems to be pretty good and is more encompassing than the regular editor, but I don't know what limitations it has compared to Photoshop CS4.

It comes with Adobe Camera Raw (ACR), which uses the same RAW processing engine as Lightroom. What it doesn't have is Lightroom's digital asset management tools (cataloging, powerful keywording, etc.)

LR is substantially cheaper than CS4, much easier to use for RAW processing and, with the localized editing in v2.x, I find I use CS4 much, much less frequently than I used to. CS4 is still needed to do detailed masks, sophisticated editing, and the other high-end editing tasks. But if I didn't already own it, I'd have to swallow hard to spend that money for what I use it for.

Again, back to your needs and "seriousness". Some of us have a fleet of software tools (plus white cards, xrite color checkers, colorimeters, and all kinds of other $$$ sinks) along with our fleet of lenses.

Others may just need LR or Elements (or Canon DPP/Nikon's free equivalent) to do all that is needed.

If you shoot Canon, I've heard the new (free) DPP 3.6 is a pretty darn good tool for basic RAW conversion.

The good news is you can probably try DPP, LR, CS4, Elements, and most of the others for free to see what you need.

Also be aware that Photshop's learning curve is quite steep. It's incredibly powerful, but it has tools for every type of user and can be a challenge.