I reproduced this locally but it doesn't appear to be a bug, just some UX weirdness. The library is reloaded properly but that window never actually does anything beyond the point that you see. You just have to close it. There is a lot of UI/UX work to still be done so I'm sure we'll revisit this at some point and make it a bit more user-friendly.
I do have a suspicion that it not seeing retail FS2 is installed is related to the case of the filenames, where it's assumed they will be lower case. If you look in /home/FreespaceOpen/FS2/, is root_fs2.vp all lower case? If not, rename it be all lower case, restart Knossos.NET, and see if that does anything. With any luck that will solve your problem.