Password checking algorithm
The first problem you face is that a password cannot be used as an encryption key. For instance, let the password be $%^gHk23. How do you interpret this as an AES-256 key?

The second problem is that the client has to send the password in clear, and then the server tries to make a key from it, and decrypt saved values.

Thirdly, the scheme is fixed. No salting whatsoever is incorporated in it, and thus it is vulnerable to a variety of attack, most notably the dictionary attack.

The hashing scheme you described at the beginning of your post is very old. Today, an extremely secure password-based identification scheme, named SRP, is gaining momentum. (See also the demo.)