I assumed it was a codec issue (ffdshow, directx, etc) problem, so I uninstalled and/or reset all of them (including re-installing DirectX 09c for XP SP3). I also used the latest Codec Repair Tool to check for corrupted or otherwise problematic codecs, and fixed the few problems it found. However, the exact same terrible playback problems remained. I've also tried resetting the cache and settings about 10 times, also with no improvement. Naturally, I also examined all the installs and updates I've applied for the last couple of weeks, and except for trying VLC 2.0.7 nightly and all the codec fixes I just described, no relevant changes were made to my system.
Then I remembered that VLC uses its own "internal" codecs as a default, so all the work on that last step was in vain! And then I tried changing the Tools -> Preferences (simple) -> Video -> Output from "Default" to "OpenGL video output" (which I'd installed some time ago), and that fixed the playback color issues.
The reason for this post, then, is to let the VLC developers and support people know about the extreme problems I've been having for the last couple of weeks with the "Default" video output preference.
I posted this here because from what I can see of formal bug reports, one has to be a super-genius to dare to report a bug that way!Thanks for listening...