A while back I reported a problem on the Cygwin mailing
list where all python extension packages would fail
"python setup.py install" at the link step due to a
mangled lib dir (-L) option.  distutils was producing a
link line with "-L.", instead of the desired
"-L/usr/lib/python2.4/config".  I've finally rooted out
the cause of this problem.

The relevant code is the if-block starting at line 188 of:
  /usr/lib/python2.4/distutils/command/build_ext.py

I've reproduced that block here for clarity of
discussion (indentation truncated for redability)

  if sys.platform[:6] == 'cygwin' or sys.platform[:6]
== 'atheos':
      if string.find(sys.executable, sys.exec_prefix)
!= -1:
          # building third party extensions
         
self.library_dirs.append(os.path.join(sys.prefix, "lib",
                                       "python" +
get_python_version(),
                                       "config"))
      else:
          # building python standard extensions
          self.library_dirs.append('.')

The test "string.find(...) != -1" attempts to test
whether "/usr" appears in the full executable name. 
This incorrectly fails in the case that /bin is in the
user's path before /usr/bin.  (i.e.
string.find("/bin/python","/usr") == -1)  Note that a
vagary of Cygwin is that /usr/bin is a Cygwin mount to
/bin.

The user-side workaround is to ensure that /usr/bin
appears in your path before /bin.  It looks like a new
and improved Cygwin special case test is needed to fix
this problem; I'm not sure offhand what the best case
would be.  Perhaps an outright test as follows would work:
   sys.executable.startswith(sys.exec_prefix) or
sys.executable.startswith(os.sep+"bin")