I ran into this yesterday and googled it. There are several forum threads where people complain that images either can't be upload, or don't go to the right places since WordPress 2.8. I'm not sure if this post will close this issue everywhere, but here goes:
I upgraded to 2.8.1. That didn't fix the problem but at least it was one less thing off the list. I wasn't going to deactivate plugins because (1) I don't have that many and (2) it didn't sound like most other people had any luck with that.
What I did was this:
- go to Settings
- go to Miscellaneous
- change the path in the box next to "Store uploads in this folder" to the default: "wp-content/uploads" and nothing else.
- change the permissions of that folder to 777
- return to the edit screen; proceed with "add image" as usual
- change the permissions of wp-content/uploads back to 755
That worked fine. The picture showed up in the post and in the media library as usual. The problem had been that the "Store uploads in this folder" path on record was a complete path leading to a C:\ drive as if for a local Windows installation of WordPress (not my case).
I hope this helps.