I had similar problems with mine so I decided to make my live cd from scratch rather than using the livecd scripts. The squashfs-tools are only needed in the initrd.gz file if you intend on decompressing the squashed file system while you boot the system. But you usually don't need that to run the live system, since the squashfs allows you to read a compressed files system just like a normal system.
It sounds like there maybe a problem with the
linuxrc file in the /boot/initrd.gz that boots with the kernel. This file is the main file that loads into the kernel's memory and runs processes like mounting /proc /sys and mounting unionfs and squashfs files systems and other things like scsi, cdrom and dvd drives, basically everything that /sbin/init does.
Could you post the contents of the linuxrc file, it maybe still in the directory where all the building was done. Or failing that just copy the initrd.gz file from you live cd to a directory, extract it, then create a directory and mount the initrd file to that directory:
Code:
mount -t auto initrd directoryname