OK OK I SOLVED IT! I know this sounds dumb but open up windows explorer (not internet explorer), click organize, folder and search options, view, Uncheck Always show icons never thumbnails, then hit apply to all folders. This seems to restore the desktop "folder" to its original settings.
EDIT: Not solved. OK I restarted and it is back to being broken. Apply to all folders just must restart explorer.
So do any of you use CCleaner as well? Might it have caused this with its registry cleaner?