Both boxes are checked. Everything appears to be in order as far as the settings go, and I have tested that the sayHello command works in other WP installations both single and WPmu, but I don't know of any others using sub*directories* can test with...
I've enabled logging and this is what gets logged when I try to connect with Livewriter
Input: <?xml version="1.0" encoding="utf-8"?>
<methodCall>
<methodName>blogger.getUsersBlogs</methodName>
<params>
<param>
<value>
<string>ffffffabffffffce6dffffff93ffffffac29ffffffc9fffffff826ffffffdeffffffc9ffffffe43c0b763036ffffffa0fffffff3ffffffa963377716</string>
</value>
</param>
<param>
<value>
<string>username</string>
</value>
</param>
<param>
<value>
<string>password</string>
</value>
</param>
</params>
</methodCall>
2008-10-07 21:05:38 Input: <?xml version="1.0"?>
<methodCall>
<methodName>wp.getUsersBlogs</methodName>
<params>
<param><value><string>username</string></value></param>
<param><value><string>password</string></value></param>
</params></methodCall>
Where username and password are the correct username and password.
Here's a log from a working installation... everything looks right, but the former dies:
Input: <?xml version="1.0" encoding="utf-8"?>
<methodCall>
<methodName>blogger.getUsersBlogs</methodName>
<params>
<param>
<value>
<string>ffffffabffffffce6dffffff93ffffffac29ffffffc9fffffff826ffffffdeffffffc9ffffffe43c0b763036ffffffa0fffffff3ffffffa963377716</string>
</value>
</param>
<param>
<value>
<string>username</string>
</value>
</param>
<param>
<value>
<string>password</string>
</value>
</param>
</params>
</methodCall>
2008-10-07 18:09:02 Input: <?xml version="1.0" encoding="utf-8"?>
<methodCall>
<methodName>blogger.getUsersBlogs</methodName>
<params>
<param>
<value>
<string>ffffffabffffffce6dffffff93ffffffac29ffffffc9fffffff826ffffffdeffffffc9ffffffe43c0b763036ffffffa0fffffff3ffffffa963377716</string>
</value>
</param>
<param>
<value>
<string>username</string>
</value>
</param>
<param>
<value>
<string>password</string>
</value>
</param>
</params>
</methodCall>
2008-10-07 18:09:05 Input: <?xml version="1.0" encoding="utf-8"?>
<methodCall>
<methodName>wp.getCategories</methodName>
<params>
<param>
<value>
<string>1</string>
</value>
</param>
<param>
<value>
<string>username</string>
</value>
</param>
<param>
<value>
<string>password</string>
</value>
</param>
</params>
</methodCall>
2008-10-07 18:09:07 Input: <?xml version="1.0" encoding="utf-8"?>
<methodCall>
<methodName>metaWeblog.getRecentPosts</methodName>
<params>
<param>
<value>
<string>1</string>
</value>
</param>
<param>
<value>
<string>username</string>
</value>
</param>
<param>
<value>
<string>password</string>
</value>
</param>
<param>
<value>
<int>1</int>
</value>
</param>
</params>
</methodCall>