I found it rather ironic that right on the heels of posting my happiness over figuring out why I couldn't publish a post with images from Live Writer to Blogger, it happened again two days later. Same resulting upload failure, but a different error. This time it was a change Picasa made. There was a small discussion on the Blogger Help Group, but no info on how to fix the problem. It was reassuring though to find out that others were experiencing the same problem on the same day which likely meant there would be a fix forthcoming.
When you run into trouble, besides the Blogger Help Group, check Writer Zone, the Writer Team Blog you will find under Help at the top of your Windows Live Writer program. Writer Zone did not post anything about the file upload error until after things were working again, but it is nice to be able to read the details even after the fact and it will be one of my first recourses another time. Also check the Windows Live Writer MSN Group which is another wealth of information. You'll learn things you aren't even trying to figure out. For instance, the fact that all your drafts and recent posts are backed up in a folder in My Documents called My Weblog Posts. This is especially helpful if you write a draft post on one computer and want to finish it up on another computer. The file can be easily transferred instead of having to post the draft online and then calling it up again on the other computer. I don't think there is currently a way to search this group for whatever you need to find, but one poster offered this link to Search Windows Live Writer Group.
One side note, if you wish to view your unpublished post in "Web Preview" you can update your weblog style by clicking on Weblog —> Edit Weblog Settings —> Editing and then the Update Style button or View and then Update Weblog Style. Live Writer then downloads all the pretty parts of your blog so that you can view your post in Web Preview as it will look online. Allow it to post a temporary post which will be deleted automatically, and if you get an error message that states that the style template used for editing your weblog posts could not be downloaded check this help/FAQ page. One common reason could be that of posting to a private blog. When using Blogger, if you change permissions for a moment to be viewed by anybody, update your weblog style, and then change the permissions back, that may be all that was stopping the update download.