My gosh I dont have clue what is up with this stupid timer2.
I have discarded the interrupts for now. It seems it is a different problem.
After uploading an Arduino Pro 8mhz bootloader to the chip, the LED blinks at around 1/2 second pulses (using an UNO board). Going into AVR studio, apparently this sets the fuses to select the crystal on the board as oscillator. Change that to internal, and the LED blinks every second.
However, it seems not to use timer2 whatsoever. Nada. Zilch. And I have no idea why it simply refuses to use any timer asynchronously. Everything seems to base off the internal timer- wther or not there is a timer connected to the TOSC pins or not.