I was seeing the same error. In my case it turned out to be caused by the “Windows Azure Storage for WordPress” plugin. When I disabled this plugin the issue went away (and images work as expected).
The Windows Azure Storage plugin has been known to have similar problems with Word and LiveWriter when working with pasted images or WordArt (i.e. no local file to grab).
To answer your question:
It occurs during the import process. The page clears and this text is displayed in the upper left. When the page UI renders it partially obscures the text.
