I too am experiencing the problem. A user at the office used her PC to do normal tasks, no crashes or other problems reported during that day. The next day she used her PC, she got a error indicating that \windows\system32\config\system was missing or corrupt. I followed Microsoft's instructions on KB# 823614 to restore the system file from C:\windows\repair\system, and to do this needed to boot into the recovery console, which worked. But after copying the file and rebooting, I see the same problem you do, to the letter.
From what I have been able to piece togeather, this problem results from a fix to some other problem Microsoft made regarding logging in to the recovery console in a pre SP1 environment to address a user being able to boot in to recovery mode from a Win2000 CD on a WinXP computer and bypass built in security measures on WinXP. Once SP1a is installed, you may not be able to boot into the recovery console using a pre SP1 Windows XP CD. KB Article 308402 describes the problem we're experiencing when trying to load the recovery console, and alludes to changes in how the recovery console works in a post SP1a world. There are links to download bootable floppy disks which contain an updated version of the recovery console (make sure you download the SP1a 2003 dated boot disks, and not the 2001 disks for pre SP1a).
After obtaining these disks, through, I still had the problem of what the Administrator password was. In our office, we always assign Administrator passwords, and tried using the standard we set, but it did not work. So either the password was not set correctly, or it was reset when I recovered the system file described above. Doing a little Googling, I found a password reset/recovery program on a bootable CD at:
http://wcarchive.cdrom.com/pub/simtelnet/handheld/diskback/ebcd-0_6_0-pro.rar. There's documentation included on how to reset the passwords. But after resetting the Administrator password, making it blank, and trying the boot disks again, I am still told that the Administrator password is still invalid. And even if it were, I don't know what good the recovery console would be to me at this point, as I would really rather like to log in to Windows, but I think the two problems are related.
At this point, it's quicker for me now to copy the user data off of the drive to another drive (i.e. mount the drive in my PC and back it up), and reinstall Windows than to try to remidy this problem further. But if anyone wants to pick up where I left off, feel free to drop me a line as to how it was resolved at (e-mail address removed).
Cheers!
----- Mike C. wrote: -----
My XP Home edition keeps booting up, posting this error
message. LSASS.EXE Error "When trying to update a
password the return status indicates the value provided as
the current password is incorrect", then it reboots itself
and continues this pattern. I can't get into recovery
console either becasue my administrator's password was
changed as well when lsass.exe because corrupted. HELP!!!
