I had similar frustrations, so I found a lead here to a plugin that does the job well. It's "Filosofo Old-style Upload Version 0.5" by Austin Matzko which does a better job than the default WP utility. In addition to thumbnail generation, it will allow you to browse for uploaded images in a viewer and select the one you wish to "send to editor" (ie: direct into the text box where it can be positioned manually). You can choose to include the thumbnail or a full-sized image in your posts/pages, depending on your need - and you can switch on/off the linking as you wish. You can also browse for images in the viewer.
To be honest, I was on the verge of stripping WP 2.0.2 off my server and opting for something else before I discovered this plugin. It's not perfect (I'd like to be able to choose by image name or description - useful if you have several different-sized similar images residing in the folder) but better than the built-in WP utility.