Elrond, why?

As others have said, Elrond probably had a moment of bad judgement. Yes, he should have made Isildur put the ring into the fire, or pushed Isildur in with it if he wouldn't surrender it. But give the guy a break! He did just fight a no-holds-barred contest with an immortal god. I'm sure he was quite tired after such a conflict and wasn't thinking clearly. Apparently Isildur wasn't thinking clearly either, as is evidenced by his subsequent repentence (see Unfinished Tales) and wasn't just stupid.

Besides Elrond being exhausted, how often have you had a gut feeling that something wasn't right, but went along with it anyway and it turns out that your gut was right? I get them all the time. Elves aren't omniscient (see e.g., the flight of the Noldor in the Silmarillion, they behave like asses), but they do act in a better way more generally than men do.

Another thing, don't believe the movie version. As entertaining as it was, it seemed to me that most of Mr. Jackson's rendering suffered from an excess of exhuberance. That is, in Mr. Jackson's version, it wasn't enough for Elrond to disagree with Isildur about the ring, but he had to SHOUT it at him because he knew that it was terrible and men were weak and stupid.