You will have to get a new hard drive. Hard drives are cheap. I bought a 120GB IDE Seagate off of newegg as a refurb for $9.99 with free shipping and 1 year warranty for my daughters Pentium 4 HT system. It had 18k hours of use, but was still healthy with no bad sectors etc as tested with Crystal Disk. Ebay is another cheap alternative to a Hard Drive, but be sure it had a warranty to not be DOA.
Microsoft does not allow OS to install to thumb drives to protect from Piracy. If you need an OS that runs off of a USB thumb drive you will have to go with a Linux Distro, with many to chose from, however the computer will not be very fast at tasks as for it has to load over USB the programs to memory. Wanting to run Windows 2000 means that the hardware might be USB 1.0, 1.1, or 2.0. I have tested on USB 2.0 Linux and it works but it is by no means fast even on a quadcore computer everything lags when having to load from the USB stick. Older computers I have that are USB 1.0 or 1.1 dont support booting over USB, but if they did it would be way more painful in lag between slower USB communications as well as the fact that the CPUs are only Pentium III's on these systems. I have Fedora 17 on a thumb drive that works well and supports wifi etc.