Wrong. There is no encryption with this feature alone, it uses access control. Encryption is a separate feature, and with XP at least was only available with the professional version. Encryption would work fine in FAT and FAT32, the difference is that NTFS stores the owner of files and has permissions related to its access whereas FAT doesn't store this information. To FAT a file is just a file with a last modified date.

In theory  if someone had a Linux boot CD which supported NTFS then they could easily circumvent this. Equally as likely if they were able to remove the hard drive from the computer and insert it in another computer as an additional drive, using another OS such as Linux.

Don't rely on logins and related features for anything more than casual security. For most of us this is plenty enough, but if you ever had to secure business information on a computer which was physically accessible by people who wouldn't normally have access to that data it is well worth considering. Equally it is unlikely this would stop hackers gaining access to the files, where encryption could prove of some use.