Another data point for anyone on the dev team trying to hunt this bug down: I had the same problem as the OP, and was also able to resolve it by downgrading to 8.6i, but was not trying to do cross-region playback. I was trying to play region 1 DVDs on a region 1 drive.
lenovo ThinkPad T400
Windows XP SP2
ATI Mobility Radeon HD 3400 Series (driver 8.503.2.2000)
HL-DT-ST DVD-ROM DU10N (driver 5.1.2535.0)
VLC Player 1.0.2
Downgrading to 8.6i resolved the problem.