I had the same problem on my desktop, booting Windows XP. On boot, instead of the logon screen, I got a message box from lsass.exe saying, "When trying to update a password, this return status indicates that the value provided as the current password is not correct." Then the system would restart itself, and re-display the message, over and over.
I was eventually able to recover as follows:
1. I installed a second bootable drive in the PC and booted into it. Then the first (bad) drive (now labeled D
was visible under Windows explorer.
2. I copied all "Security" files from D:/Windows/repair into D:/Windows/System32/config .
3. The drive would now boot again, but since I originally had a password at login time, all files under "My Documents" came back as "Not accessible" when trying to access them.
4. To recover the "Not accessible" files -- all my documents! -- I downloaded and ran PC Inspector File Recovery (free from Download.com) which worked great.