The system.log file says
Jul 4 13:01:46 robert-davis-computer [0x0-0x2b02b0].com.parallels.desktop[4601]: QFSFileEngine:

pen: No file name specified
-- This was starting up parallels
Jul 4 13:03:08 robert-davis-computer /System/Library/CoreServices/Finder.app/Contents/MacOS/Finder[184]: StatusMonitor::volumesChangedCallBack returned -47
-- startup of vm
Jul 4 13:04:30 robert-davis-computer fseventsd[29]: log dir: /private/tmp/4601/C/.fseventsd getting new uuid: 0F73526B-D3A0-4EFF-976B-892337281BE6
-- Windows up, and user logged in.
Additional:
1. ICQ wants to install a new version. However, attempting the automatic upgrade fails half-way through.
2. At startup, windows pops up an error box saying,
\\.PSF\.Home\Documents\Windows XP profiles\Owner\Local Settings\Temp\pft27.tmp refers to a location that is unavailable.
In fact, that location is available. That is the correct location for Owner's profile (set in registry editor after installing parallels and the VM).
That particular directory is not there; that temp directory is huge.
This is believed to be coming from a third party CD that is trying to install stuff.
3. At startup, parallels tools tries to run, and complains about a lack of space.
This is the "An error (-5006: 0x8004232b) has occurred while running the setup.
Please free up at least 5034 KB on your \\.Psf\.Home drive before you run the setup." message
Trying to "Report" this issue brings up a web page saying that the page I'm looking for has moved.
http://www.parallels.com/InstError.asp?Code=-5006%20(0x8004232b)&Info=>SetupDLL\SetupDLL.cpp%20(1469)PAPP

arallels%20ToolsPVENDOR:%20(www.parallels.com)PGUID:B730E908-1FD5-4170-A0FE-B6AB874344F0$10.50.0.132PAK@Windows%20XP%20Service%20Pack%202%20(2600)%20IE%206.0.2900.2180
I have verified that \\.psf\.home is writable.
Ok, did you mount it as read only, or you selected Shared Mac Folders to Windows and checked Home Folder?
FileVault?, any antivirus on Mac or Windows?
No fileVault.
No Mac anti-virus.
Avg 8.0 was just installed last night on Windows. These problems were happening before Avg was installed.
I have shared mac folders turned on.
I have home folder sharing turned on.
Checking Regedit:
HKEY_Local_Machine\Software\Microsoft\Windows NT\CurrentVersion\ProfileList\<my id>\ProfileImagePath is \\.Psf\.Home\Documents\Windows XP Profiles\Owner
HKey_Current_User\Software\Microsoft\Windows\CurrentVersion\Explorer\Shell Folders has everything except FONTS and Administrative Tools mapped under \\.PSF\.Home. Everything that should be in the profile (the hidden windows stuff) is in that profile directory.
Desktop, Personal, pictures, and music are mapped to the macintosh desktop, home, pictures, and music directories.
Attempting the following fixes:
1. Emptying the temp directory and IE cache.
Filesystem 512-blocks Used Available Capacity Mounted on
/dev/disk0s2 155629664 92170848 62946816 60% /
/dev/disk2s3 92274688 110616 92164072 1% /Volumes/Spare drive space
/dev/disk2s4 17678256 14921560 2756696 85% /Volumes/Boot DVD
/dev/disk2s2 279572912 268607728 10965184 97% /Volumes/Seagate External
/dev/disk3s2 195488 180048 15440 93% /Volumes/Parallels Desktop
/dev/disk1s0 1206172 1206172 0 100% /Volumes/DV
robert-davis-computer:~ rcd2$ df .
Filesystem 512-blocks Used Available Capacity Mounted on
/dev/disk0s2 155629664 91934632 63183032 60% /
robert-davis-computer:~ rcd2$ df .
Filesystem 512-blocks Used Available Capacity Mounted on
/dev/disk0s2 155629664 91914424 63203240 60% /
robert-davis-computer:~ rcd2$
robert-davis-computer:~ rcd2$
Hmm, something that just occurred to me.
To install parallels tools, the old tools probably needs to be stopped, and the new one started. When the old one is stopped, I'm guessing that /.psf is no longer available.
Is it a case of "Install the new, leave the old running, and force a reboot to load the new" -- in which case \\.psf stays available, or is it "Stop the old, start the new, do not reboot", in which case there is a gap where \\.psf is NOT available? And would that cause the problem seen here with installing the tools?
Testing for this: Run the tools installer with the other dummy windows account (no special regedit settings ...)
Hey, that does it! And it's asking for a reboot anyways

.
Alright, that solves parallels tools. It doesn't solve the other stuff.
Next "fix": There is no entry in there for "tmp". Lets add one, and point it to \\.psf\.mac\tmp, in case it is the length of the UNC causing trouble (it should not, but ...)
No, entering a value for "tmp" in Explorer\Shell Folders\ does NOT change the value of %TMP% or %TEMP%. Both still point to the calculated value under the local settings.
Reinstalling the problem software as the dummy user does work.
That's not a good solution -- some software installs as a single-user, not a system-wide install.
Well, the problem at least is identified -- if the entire windows profile is moved off the windows drive onto a UNC-speficied path, then things fail. However, the system has been operating this way for a long time now. The "failure" things are few and far between.
Is there a good solution on the parallels side?
Is the only answer "maintain a dummy account on windows just to install some problem software"?