AD Loopback processing

I am having a problem with folder redirection. I have the My Documents folder redirecting to a different \\server\userfiles\%username%\My Documents. Some folders are being redirected and some are staying in the C:\Documents and Settings\%username%\My Documents, the problem is the cache is deleted when the user logs off. That means that their files are disappearing. I am running Windows 2000 Terminal server and have loop back processing turned on. I think that the redirection is not workingbecause I get an Event ID: 1000, that says Windows cannot do loopback processing for downlevel or local users. Loopback processing will be disabled. Any help is greatly appreciated. My users are becoming restless and they will be asking for my head soon.