Oh, and check where you have C2 connected.
I borrowed that part of the circuit from sparkfun (one of the arduino pro boards). I currently do not have anything connected to the FTDI header, it was intended as a programming header. Would having the FTDI side of C2 floating cause problems (and why, I am trying to learn)? I will probably just remove the FTDI header in the next spin of the board.
If having that capacitor there is intentional, it's certainly a weird way to go about it. It might work, actually, depending on how long of a reset pulse is needed. When you yank down on one side of the capacitor, the other side will pull down as well, but then it'll charge back up. Not really a very "proper" way to do it, whatever "it" is.
I suspect they meant to put it between RESET and ground, to prevent noise from causing resets, not in line with the reset signal. The reset signal should go straight out from the reset pin to the header, maybe in series with a small (10-100 ohms or so) resistor to help with static protection, but not in series with a cap.
I am now too tired to properly analyze the real question here, so I'll leave the power supply stuff for people in other time zones so I don't make an ass of myself
Edit: The cap in series indeed appears to be common on Arduino boards. Looks like a hardware correction for people leaving the reset line low instead of just twiddling it down and back up again. Go ahead and leave it like that, but make sure you use the right resistor and capacitor - the time of the reset pulse will be determined by them. Not really how I'd choose to do it, but clearly if it's been done that way since the first Arduino, it's stood the test of time and works just fine.