I'm just wondering if it's possible to create folders in the XMB.

The main reason is I want to organize things. I'd like to store all my demos in a demos folder, all my PSN games in a PSN folder, etc...

Is this possible?

Not yet but we are all hoping for it in a future firmware upgrade.

I really hope they do it soon.

I loved the XMB interface because its so clean and easy to navitage, but now my screen is getting cluttered with the douzens of trailers, demos, and psn games.

I hope they add this function so you can keep better track of your friends, too. Would love to have the ability to put all of you in an AVS folder in my friends list.

yup me too.

I hope they add this function so you can keep better track of your friends, too. Would love to have the ability to put all of you in an AVS folder in my friends list.

Great idea. I really lose track of who are my friends on the list.

When I uploaded some pictures via USB, PS3 copied the folder that the pictures were in.

I think it just copied and grouped them by date. But the PS3 will see folders on USB memory sticks/hard disks. Not so elegant but it does work.

If you have the folders on your USB drive set up like this, the PS3 will let you them:
USB root\
PICTURES\
Vacation 2007\
Party 1\