Rootfs is limited to 256mb of memory on a separate chip that's attached to the processor if I'm not mistaken.
Every program installs a bit of itself in rootfs, some more than others, and the rest of it it installs on other parts of the device.
Now, it runs out real quick, so you have to be aware of it, a good way to keep track is to download conky (or the desktop command widget) and check it out once in a while.
If you run out of space, you can't install anything else.. Firmware updates require huge amounts of rootfs space (Just for installation) and updating can be extremely problematic.

Not sure if you know all that already or not, but maybe it will be helpful to anyone else who comes in here.

Edit: Alright, I've created a wiki page for rootfs, I put your explanation in it too rob1n, I hope you don't mind.
http://wiki.maemo.org/Rootfs