If the list elements appear with bottom borders when hovering, then the browser is behaving correctly. The effect, when hovering using IE7 Beta 2 Preview is that the entire UL element disappears beneath the masthead image. If the masthead image is removed, the LI elements appear with their appropriate behaviors.
I do not know of a workaround. z-index does not seem to have any impact when placed in any of the element combinations I've tried. The only way I was able to bring back the proper rendering was to rework the CSS completely, shortening the masthead div and abutting the second div beneath it without overlap an can be viewed at vinetype.com.
Proper behavior can be seen with IE7 below
The layout behavior above is fixed by correctly spelling the class name seconddiv in the second
Bruno Fassino, however did create a simplified test that behaves similarly even when class names are spelled correctly, and agreed for me to link to his page.
Visit Bruno Fassino's Hover Test