Isn't the cloth you guys talking about, just some parts of the model with jigglebones ? I don't see anywhere Valve saying they made some cloth physics system.
According to the Source wiki.
Cloth simulation
Real-time cloth simulation (i.e. soft-body physics) will be introduced to Source.
Jigglebones can be used to simulate cloth, but not realistically, cloth doesn't jiggle or float with the weight that they have; nor do they interact with such features it has. But what is new is REAL cloth simulation, and soft body physics.
Which means. (see 2:25)