As you tried to login to Windows XP Home (SP2) it showed a message and logged out again.
A problem is preventing Windows from accurately checking the license for this computer. Error code: 0x800700C1The suggested fix for error 0x800700C1 had been try re-registering regwizc/licdll or see 310794 from MS and if they don't work reinstall/recover XP - and more than likely lose your applications and settings.
In short, the answer I found was to uninstall Windows XP Service Pack 2 (SP2) using Safe Mode, which gets rid of the Windows Genuine Advantage that's causing the error. Then reboot and reinstall SP2 which resets WGA. I had to activate again (prob from resetting wpa.dbl earlier) and then install IE7 from MS Downloads before I could run WindowsUpdate.
[After reinstalling IE7 I got error 0x800703EE from WindowsUpdate which I traced to c:\windows\system32\wups2.dll - file length was 0 bytes. Deleting the file and reloading WindowsUpdate fixed that.]