Actually, if the seat is lower than it should be, the frame would be too big. A bike that's too small would end up with the saddle sky-high, much higher than the bars. Of course, that's also assuming that its height is set for ideal pedal stroke, and not to be able to reach the ground with both feet while seated (which I can't do on any of my bikes).

That seat angle is pretty wild, too.

I mentioned it elsewhere -- the problem with compact geometry frames is that the sloping top tube leaves a lot of room for misadjustment. If this bike had a traditionally horizontal top tube, he would not be able to put the seat as low as it is now.

What you say about feeling like your arms are still locked out also tells me that either the frame is too big or you're not actually rotating forward at the hips -- and that would be difficult to do with your seat tilted so far back. IF the frame is too big, simply dropping the handlebars won't help at all with reach, either -- as the stem slides down the steerer tube, it slides away from you, too.

The FIRST thing I would do is revisit the seat height. A quick way to get in the ballpark would be to pedal with your heels on the pedals -- if your knees are completely straight at the bottom of the stroke, and your hips aren't rocking in an effort to reach the pedals, then your knees will have the proper slight bend when you pedal with the balls of your feet like you're supposed to do.

IF that's how you have your seat now, then I'll say that the bike is much too big. Other bikes are designed to have the bars higher than the seat (you'll see them marketed as "comfort" bikes like Trek's Pure and Navigator series), but not the FX.