I’m having the same issue, but this is a brand new install. I’ve installed over a dozen WordPress blogs, most on the same server as this one, but all are older versions (this one is 2.7.1). Never had this problem with the older versions.
I’ve tried a different browser (FF3 & IE7), I’ve tried a different machine. I’ve checked miscellaneous settings. Folders have been chmod 777. I have re-uploaded ALL the WordPress files. I’ve verified that Flash 10 is installed.
This sure seems like a WordPress problem to me.
I could upload the pics via FTP and then type out the URL path, but it doesn’t seem like I should have to.