No, 169.x.x.x is not reserved by IANA. In fact most of it is Internet sites. I think the IP's he's using are actually assigned to Microsoft.
RFC 1918 DOES specify a number of networks reserved by IANA for the purpose you mention, namely 10.x.x.x, 172.16.x.x-172.31.x.x, and 192.168.x.x.
In any case, configuring the machines manually is definitely a good next step to helping determine what's wrong with the network. Also try using ping, netstat, etc. to diagnose the problem. There are quite a few nice tools on the Internet for basic network diagnostics.