How big is Froyo's kernel? Some people have issues if the kernel is larger than 2.2mb. This would explain the problem if it is larger than that.
Just providing a history of my phone if that helps-
1- a month back or so, i tried to install the stock Froyo update when it first got leaked.
2- every thing went on smooth without any error but when i rebooted my phone after the flash, it went into an unending loop and never started.
3- At that point i unlocked my phone and then tried to install Paul's Froyo and got the same error as i have posted in this thread.
4- I tried out various things but nothing worked.
5- Then finally i tried CM mod 7.0 and it flashed seamlessly.
6- Now when i try and install this ROM, the same ghosts are back.
7 - guess something went bad in the first point itself.
I have been trying to find a soilution to this problem.But not successful till now.