>Is it a problem that I formatted Disk 1 as FAT32? Should it be just FAT instead?
Not the problem. FAT32 there is fine.
The NT boot loader operates from disk 0 (first disk), which is not a problem for NT whether that partition is NTFS or FAT32. But when the NT loader tries to boot W98 it transfers control to the W98 boot loader, which has to have FAT/FAT32, not NTFS. If you want to boot w98, W98 has to begin booting from the first partition on the first disk and that partition has to be a file system W98 recognizes (FAT or FAT32), not NTFS.
Redoing partitions is simple if you have Partition Magic. Otherwises you have to wipe the partitions and start over. In either case you should back up what you need to keep, and be prepared to restore it.
There are some free partition resizers, but they are more oriented to linux I believe, and may not handle NTFS partitions.
Otherwise you can boot W98 from a floppy if you find that acceptable.