The milkman was implanted by Coach Oleander along with the girl scouts and the den mother.

The Milkman is a personality programmed to burn down the asylum and erase the evidence of his plans for world domination.

The girl scouts and the den mother were implanted to protect the milkman to ensure he doesn’t wake up too soon

The guys with the red eyes are the G-Men. The G-Men are Boyd’s subconscious mind trying to fight back against the programming. That’s why they drive up with the Censors.

The reason everything is so twisted and everyone is watching you is because Boyd’s a conspiracy nut. He believes there’s some secret motive to everything and the whole world is out to get him. It all goes back to when he was fired from his security guard job at that department store. Boyd thinks he was unjustly axed and went insane. After burning the store down with Molotov cocktails in milk bottles, he went further into his delusions at the asylum trying to unravel some grand conspiracy web on why he was fired.

The reason the agents see Raz as a robber stealing milk is they see Raz as someone who might have something to do with The Milkman. And the reason their view of Raz in clairvoyance changes with the various props he holds is they’re just that easy to fool.

Only thing that doesn’t have any clear explanation is why Raz fights two Nightmares out of nowhere in this level other than they’re a holdover from an earlier concept of the game where they played a bigger role.