Just been banging my head against the wall trying to get diagramming working in Sql Server 2005 for a Sql 2000 database I restored. It turns out that I needed to run a couple of stored procs to enable this:
EXEC sp_dbcmptlevel @dbname ='<databaseName>', @new_cmptlevel = '90'
GO
use [<databaseName>]
GO
Alter database [<databaseName>] set parameterization forced
GO
If found this info in a bigger article about upgrading the whole sql server:
http://itknowledgeexchange.techtarget.com/itanswers/upgrading-microsoft-sql-2000-to-sql-2005/
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