Do you have a system install disk that's on an optical disk (CD or DVD)? Is this USB thumb drive the only external disk you've tried?
The gold standard for a system installation is off the grey Apple DVDs included with the computer. Try that first, if you can. You can also use a retail Mac OS X install DVD; the minimum system required for your computer is Snow Leopard 10.6.3 - nothing lower than that will boot your computer.
One issue is to isolate whether there is a general USB problem, or a problem with this specific USB drive. Try plugging an ordinary working USB mouse into each port, and check to see if it works. If the mouse doesn't move the cursor in one or the other port, it's likely that a port has burned out. If neither of the USB ports works, it's possible that the USB controller has burned out - or possibly that the USB drivers have gotten goofed up, and need to be reinstalled.
What do you believe is on the USB drive/stick? My suspicion is that USB works fine, but you're trying to boot off a USB stick that isn't actually bootable. If you start from the hard drive, and then attach the USB stick, what happens? If a disk mounts on the desktop, that's good; if it appears to be an OSX install disk, that's better. But if the OSX system is older than the one that the computer was built with, it won't be bootable.
Launch System Preferences, then select Startup Disk. If the system on the USB stick is bootable, it will appear there.