I have tried all the proposed .htaccess tricks, disabling plugins, changing permalinks, CHMOD’ing folders here there and over there – so far with no luck.
Then I ran into this post from raffo:
1) go to https://code.google.com/p/swfupload/
2) download the latest pack
3) from the folder FlashDevelop/flash9 copy the file swfupload_f9.swf
4) paste it in your wordpress installation, and exactly int the folder /wp-includes/js/swfupload
5) from the folder FlashDevelop copy the folder plugins
6) paste it in your wordpress installation, and exactly in the folder /wp-includes/js/swfupload , so to overwrite the existing folder
Now that didn’t exactly work (same error), but I tried downloading the new Beta release: https://swfupload.googlecode.com/files/SWFUpload%20v2.1.0%20Beta%202.zip
And copied that into my wp-includes folder as stated above, and it worked!! Mind you you will get some errors under the upload window as WordPress isn’t expecting version 2.1.0, but it works perfectly. Also note that I tried this with a blank .htaccess file. Good luck, and enjoy a working WordPress 2.5.