I started my blog, TSL, back in April 05. At the time, I had full functionality and no complaints about Blogger, but some months later my image upload functionality disappeared. No notes about it in Bloggers "known issues", no talk about it on help boards, and no response from Blogger in regards to my issue. So for months now, I've been without FTP ability directly from the blog sw, which is quite a deterrent to posting images (easily), I could still go in to my FTP site and upload things manually, but that's a time consuming drag for something like posting on a blog, where the key is ease of functionality.
Well, I finally got around to poking around Blogger today for any update on the issue, and sure enough it was a known bug. Turns out in some cases, for whatever reason, you must fill out the username and password field in Settings / Publishing tab in order for the image icon/tool to work. So sure enough, my fields were blank (as I had it set up to manually log into FTP), and once the fields were populated...
Image icon has returned, as seen here
Turns out they've even added some more formatting functionality!!