I have the same problem. And I can replicate it.
The problem comes about when I install ExamSoft SofTest. This is a "locked out environment" type of software used by many schools for their final examinations. The intent of this software is to provide a rudimentary word-processor and file delivery mechanism into which the examinee writes his exam answers; plus, most important, also to preclude any other software from running while ExamSoft's software is running, thus ensuring that the examinee cannot cheat by looking at notes stored on his computer. Somehow there's a conflict with user-ids, user profiles, or perhaps merely something about anti-virus, in the manner in which ExamSoft installs its SofTest.
I have determined to my own satisfaction, by means of installation, removal, and intelligent reversion to a variety of intermediary restore points, that the problem initiated for me when I installed ExamSoft's SofTest software. The problem goes away if I restore to a point in time immediately before installation with no other variation in environment, software, settings, or updates, so I feel pretty sure ExamSoft is MY culprit. Yours may be different. That's just the vehicle through which the problem gets delivered. I do not know the specific problem. It is somewhere in the Registry values (of course ...).
Windows 7 Libraries do operate properly in and of themselves, but do not operate properly in the Common File Dialog that is brought up in most programs.
Elaboration of symptoms
My experience is, that my Libraries are intact and not hidden, and are visible and operate properly in their own folders (in Windows Explorer). But in most programs and applications, they don't work properly. If a dialog is used in, for example, MS Word, to open or save a file, then the names of the Libraries do appear, but they cannot be further navigated. This problem exists in any Common File Dialog (open, save, save as, attach, etc.) in any program that is in a Program Files sub-folder, but NOT for any program that is in the Windows sub-folder. So, Notepad (which is in Windows folder) f.e. can use Libraries correctly; but MS Outlook or Firefox cannot. In the broken File Dialogs, the Libraries appear but seem to contain no files. Oddly, if you right-click in a Files Dialog on a seemingly empty Library, the subsequent Libraries Properties indicate that the Library does have contents, but do not show (or allow modification to) the contents. In other words, for most software the files in the Library are "there" but are not "visible" or "viewable" or "usable" via the software; but for some software (including Notepad and Explorer) the Libraries seem quite normal.
I haven't found one. Trying anything akin to re-establishing the default Libraries, or somehow in another manner removing or disabling and then re-installing the Libraries, fails. I've been through some Reg-Edit based solutions that I found by Googling across the 'net, but none have been effective. One other oddity is, that I find to my surprise that I now lack privileges to modify one of the Library registry keys even though I'm king-god-administrator of my own machine and have no other user account profiles running on it. ExamSoft has decided (probably in the name of preventing cheating during exam time) to lock me out of certain access privileges. I do not approve but, because I must use ExamSoft, I have no choice.
I won't dicker with it until after the exam in question, which takes place in late February, so that I don't rouse the alarm of the anti-cheating device. I'll just live with broken Libraries until then. Then I will uninstall the ExamSoft product and perhaps undertake a system-restore all the way back to mid-December (and have to live through re-installing all the intervening updates, yeesh ...).
Sorry to resuscitate an old thread. I feel fairly confident in claiming that this arises due to installation of the "exclusive" exam-environment software on my machine (Windows 7, HP relatively new laptop, all updates installed). I am not interested in a foundation-level solution, since editing Registry keys is really beyond what anyone should have to do simply to make expensive end-user-friendly software operate properly, but if there's a quick tweak (something like, "Re-Install Default Libraries", but one that works) I'd be happy to hear about it.