Did you try "Last known good configuration" in the Safe Mode list of options? (You call it Diagnostic Start-up mode I think).
Also, can you check that System Restore message. You said you tried to run System Restore but it said system restore could not protect this computer. I don't know all the SR error messages, but that sounds unusual to me. SR takes the operating system back to a previous time. It's not a protection device like an anti-virus or anti-spyware.
If last known good configuration doesn't work and you have to carry out a complete re-install, does the owner have any important files/documents, etc that he needs to save? If so, consider using a Linux distro called Knoppix. You can burn it as an ISO to a CD and run it as an operating system from the CD. It loads up to a desktop and from there you can explore the computer's hard disk. That way, if the computer has a 2nd CD/RW drive you could possibly copy all his files off the hard drive. This site gives more detail;
I was called in to look at a computer belonging to a priest in my parish. It's a newer HP Pavillion, Athlon 64 34000, 512MB PC3200, XP Home SP2.
He had been running Norton Internet Security and Antivirus 2007, all the automatic updates, I believe. The priest is kind of a computer novice and he is also deaf... so it was hard to know exactly what happened prior to the problem.
Anyway, when I started the computer... it loaded VERY slow (I assumed it was all the pre-loaded HP bloatware)... when Windows finally reached his desktop... only the "safely remove hardware" icon appeared in the sys tray. No antivirus, no wireless network icon from his wireless NIC. I tried to load NIS manuallly, it would not open. Tried to open Internet Explorer, the browser flashes for a second and then disappears. Tried to look at the Windows Firewall in the CP, cannot access it. Tried to run System Restore... it said system restore could not protect this computer.
Does this sound like the M.O. of a pest? I tried installing AVG antivirus from a CD and it seemingly installed fine, until the very last step when it told me that it couldn't launch the *.exe file. I tried loading Windows in a "Diagnostoc Start-up mode"... all the same symptoms persist. Odd?
It's relatively new, I think... I have already backed up his documents... so I'm thinking of trying a destructive recovery of the whole OS. Any suggestions before I do so?
Thanks in advance.