I have a similar problem, which occurred out of the blue about 4 weeks ago. First I got the HTTP error after the upload was “crunching”. The photo was still there I could insert it although it was full sized and I could not decrease and since “crunching” apparently did not reduce it size, it took longer to display. When inserting it, I would have to reduce it four times to get it to a reasonable size and no caption information is available. Then the flash uploader stopped allowing me to browse for the photo to upload on my computer. If I used the browser uploader, it gave me a server error. I loaded WordPress 2.8.2 yesterday and I still have the same problem, although my flash uploader will now browse my files. I inserted the security code in the htaccess file and changed the permissions to 777 with no change. Note that I get the same problem if I use a Mac or a PC and using Firefox, Safari, IE. If anyone out there has a clue how to fix this, I would be ever so grateful.
