err=2 isn't really a message....
Funny, I found tons of info by searching Google for 'lilo "err=2"'
As far as I can find, it means the kernel got corrupted (*shrug*).
Update to the 2.6 kernel. Boot into your installation (off cd2), mount cd2 (mount /dev/cdrom), go into the directory /mnt/cdrom/testing, and find the set called linux-2.6 (or something). Once you're in the 2.6 directory, run "installpkg *.tgz" (or maybe *.tar.gz, I forget). Then run lilo and reboot. Hopefully that'll work.