I had a similar issue once before. I'm pretty sure the issue I had was whenever I tried to open a folder, it would instead give me a new console window with the current directory set to the folder I was in. I think I ended up fixing it by going into a virtual machine, making a copy of the registry keys in question there and then applying it on my main machine.
Directory and File Folder. Those are the (abridged) registry keys for those two; hopefully you'll be able to check them to make sure they do what they should and then apply them (Try the file folder one first) and hope for the best. Copy them to their own files and rename them
Run them, and say yes to the merge question. That should fix your issue; if it doesn't, try opening the registry editor with Start->Run->
regedit.exe, then navigate to
HKEY_CLASSES_ROOT. Make a backup of both
Folder, then delete Folder and apply the script I linked. Do the same for Directory.
If that still doesn't fix it, I'm not sure what else you could try. Reinstalling windows is a thought, I've done that to fix some particularly difficult issues. Good luck, and be careful! The registry editor is a dangerous tool.