Does this problem happen if you logon as a different user? If not then recreate your user profile on your pc. I'm assuming that you are using WinXP Home Edition so logon as the administrator (press alt+ctrl+del twice to get a logon promt) and rename your user account profile name to old ie john_old in windows explorer. Your profile will be located in C:\Documents and Settings\. You can copy your favourites and my documents folder over to your new profile once it?s been created. Now logoff as the administrator and log back on as your user account and test if you still have issues with hotmail using IE. If you don't then copy what ever folders you require from your old profile to your new profile and you should be set.
If you are still having problems I would suggest that you try a different web browser such as mozilla before even thinking of blowing away your XP installation.