Recently, after I installed Photoshop 7 I lost the ability to right click on an image from Windows Explorer (I could still do this from IE, but not Windows Explorer), and choose Set as Desktop Background. Seemed to be file associations at first, but even after I re-associated jpg images with Windows Picture and Fax Viewer, I still couldn't set an image as my wallpaper through the righ-click context menu.
Well, FunkyLamb has found us the fix for this problem!
Click on Start->Run and then type in:
regsvr32 shimgvw.dll
and hit ok. Now this option should be restored to your right-click context menu on allowable images.