How/Can I make two folders in WMP?

You would do that by creating 2 new playlists. One called Hubby and One called You, or whatever Add his songs to his playlist and add your songs to yours. From that initial point you then have 3 ways to view your music. All as now, click your playlist and only yours show, click hs and only his show. You can of course go on to make as many seperate playlists as you want after that but that will give you what you want now.

No you must keep the library you have now - the name given to the database of all the songs you see when you view 'all music', as playlists created in WMP are made up from the library. You never need yo view 'all music' though and what you're actually playing with when you organise in WMP is just the database list of shortcuts to your music, the actual music files themselves remain untouched.
Just had a thought, you only need to make a playlist of your own songs don't you? And let him trawl through the full library, including your songs, for his.