Start with an image. (any image)
Add a new white layer and paint soft black lines across it using a soft brush. Like this.
Duplicate that layer and set it to screen. Turn this layer off until later.
Set the first layer you created to multiply.
Go into Filter/ Liquify.
Distort the image like this and save the mesh to your desktop.
Apply the Liquify mesh to the other layers by clicking on the layer and then going into Filter/ Liquify and then load the mesh that was saved to your desktop.
Create a soft mask like this.
and apply it to all the layers. Turn the screen layer back on and lower the opacity until you like it. Add a shadow layer under the original image.
You can even add an adjustment layer to the top to brighten up the area where the folds are.
Layered file: http://www.box.net/shared/chy9s3d2s7