Disassemble PS2 Controller.  Remove vibration motors (this is where the AVR / XBee will reside).  Cut the controller cable which plugs into the actual console; this is no longer needed (depending on the layout inside the controller, you may be able to reuse a portion of this cable for step 2).

Solder wires onto the Blue, Brown, Orange, and Yellow wires, plus GND / VCC (Red and Gray).  Solder to a 6 pin female header.  (Or, if you have enough room inside the controller, you can use the last couple inches of cable, and just solder this directly to the 6 pin female header).

Solder up the AVR + regulator onto a perf board, according to the schematic.  Include programming headers (MOSI / MISO / SCK / RESET) and a 6 pin breakout for the PS2 controller wires you soldered last step.

The schematic for this is below:

Program the AVR.  The analog light should turn on once the AVR is talking to the PS2 controller.  When you press a button, you should see data on the receiving serial port link.

Glue a 3xAAA battery holder to the outside of the case.  Connect the power switch in series with the positive side of the battery.  Re-assemble the case.  You should now have a self contained unit with batteries on the outside and a switch.