It's very likely suffering from terminal rust. But start by totally dissasembling it and see what you find. It COULD be that someone with little skill had it apart for whatever reason and put it together wrong. For example the upper bearing race being in backwards COULD cause this. But more likely it's just suffering from long term neglect.


Clean out and carefully inspect the cups and cones for rust pitts. If the corrosion has eroded rough pits in the races then your only solution is a whole new headset. But if you catch it on the "cusp" where the balls may be shot but the races themselves are only a little discolored then new balls in the bearings will save the day.