This problem is not Vista specific--in addition to Windows Vista Ultimate, the problem also occurs on Windows XP Media Center Edition 2005 and Windows XP Professional, all fully updated. My linux install died, so I cannot test it there... Could anyone test it in a Mac or some other platform to see if the problem is specific to the Windows implementation, or something else?
Test Procedure:
back up your vlcrc file (wherever it may be)
delete the original vlcrc file (start from default settings)
download the latest nightly build for your platform (if available, or get the source from svn and compile if not)
run vlc-0.9.0-svn-20071007-0001 <-- build I downloaded today
exit vlc (this will recreate the vlcrc file)
edit the vlcrc file
remove the hash mark from the beginning of the line that says "embedded-video"