Microsoft issued Service Pack 2 and Service Pack 3 for XP to patch (and "improve") the OS. The list of patches and downloads for XP are here: http://www.microsoft.com/downloads/en/resultsForProduct.aspx?displaylang=en&ProductID=4c937a02-bae0-4317-a1a9-0c56cd979d05
You needed to install the service packs to continue accessing Microsoft's updates for your computer. Microsoft assumes you don't want to lose this data. You could get rid of the problem by reinstalling the entire OS from your current disc (if you have a full version, if you have an update version of XP you'll need the OS disc for Win95, Win98, WinMe or Win2K). Start with formatting the hard disc. However, you will lose the ability to contact MS for updates with Windows Update until you manually download and install the Service Packs (including SP3).
Alternatively you can build a new recovery disc for your current XP version, if you take the IT versions of the service packs. This takes several steps - first you need to copy all the files from the CD to a hard disc. Then you need to slipstream in the service packs. Then get the boot image files from the CD and create a new .iso with all of the files. For SP2, http://www.winsupersite.com/showcase/windowsxp_sp2_slipstream.asp
has more information on the details.
If you want to add the SP3, you need to add the following set of steps: http://www.winsupersite.com/showcase/xpsp3_slipstream.asp
I hope you can get your machine to function.
(if you have information that you want to save, you may want to try using a LiveCD with Unix with an external drive (optical or hard disc formatted as a FAT 32 drive) attached.)