1. First of all check if "drag and drop" is enabled.
Both the options below should be checked.
Right-click the Start button, choose Properties, and click Customize. If you’re using the default Start menu, click the Advanced tab and then, in the Start Menu Items box, select Enable Dragging And Dropping. (If you’re using the classic Start menu, in the Advanced Start Menu Options box in the Customize Classic Start Menu dialog box, select Enable Dragging And Dropping.)
There is another setting for "Drag and Drop" in your IE options.
Open IE > Tools > Internet Options > (tab) Security > (button) Custom Level and scroll down to "Drag and Drop or Copy and Paste Files" (under Miscellaneous).
2. If that does not help,
Line 233 right hand side
Save the REG File to your hard disk. Double click it and answer yes to the import prompt
3. Try another mouse
4. Run system file check. You will need your XP installation CD for this
Start/Run and type in
sfc /scannow (there is a space before /)
5. Have you checked for malware?