I fixed it! After hours of reading and trial-and-error fun, I finally came across the following information about the psaux implementation for 2.6.x:
Ivan Popovski has found that the psaux module does not work correctly on devices capable of multiplexing the PS/2 mouse port. You have such a device if dmesg says
i8042.c: Detected active multiplexing controller, rev 1.1.
or something like that. Don't be disappointed. By disabling the multiplexing feature of the PS/2 port, my psaux module works again. How?
* If the psmouse is loaded as a module, use the "i8042_nomux=1" parameter when you load that module.
* Most people would have compiled-in the psmouse driver, because the i8042.c also drives the keyboard. In that case, use "i8042.nomux" as a boot parameter.
I checked my dmesg and found that multiplexing string, so I passed i8042.nomux to the kernel, and voila, the mouse worked.
Hopefully anyone else out there struggling with this issue will find this useful. At first I was thinking SMP might be the culprit, since that was also mentioned as a problem, but that seems to have been fixed in 2.6.7 (or possibly earlier), because my kernel is SMP and I have no problems using the backward compatible psaux device.