Do this,
Start Menu, Run type in "dxdiag" the screen that pops up will be on the system tab. You will see towards the bottom of that list of system info "DirectX Version:" what is THAT version... not the files. If that version isn't at least 9.xx (xx equals a number and maybe a letter) then I would update Direct X. If you truely have direct x version 7, you may have installed something that would have downgraded you. This doesn't make sense because Direct X 8 was pre-installed with XP and I didn't think you could downgrade below that... but maybe.
to update directx go here
http://www.microsoft.com/windows/directx/default.aspx
then install the newest version... I see that they are now on DirectX 9.0b!
I will be away from my computer for 3 hours, so I will check back on your progress around 4:30 PST. Good Luck!