The navigation pane in Windows 7 lists Libraries as a separate category by default, as in the picture below:
In some systems, Libraries may be listed under Desktop, and users may be wondering why it’s listed so all of a sudden, or think it may be due to inadvertent dragging of Desktop icon over Libraries or vice-versa. It’s not so. There is a simple (but overlooked) setting for the navigation pane where in you can choose to show all folders or not.
Simply right-click on a blank space in the navigation area, and uncheck "Show all folders".
Alternately, you may change this setting via Folder Options applet as well. Refer Working with the Navigation pane at the Microsoft site.