This seems to be a problem caused by having a write-protected Documents folder. Firefox tries to create a "Downloads" folder whatever your Documents folder is located. I fixed this problem by manually creating a folder named "Downloads" under "My Documents" (which for me happens to be located on a write-protected network share). My advice is to open your Documents folder, and try making a folder named Downloads. Then see if it works.

I'm not exactly sure if this is a bug, but I think it might be. It's annoying nonetheless.

Thanks for the reply, but my downloads folder isn't write-protected. Just to check, I created a new folder and switched the downloads to go to that, and still nothing happened.

I actually solved it by turning off the Download Sort add-on. Even though it doesn't say, I think it's incompatible with the new version of Firefox

When this issue arose with older versions of Firefox, you could delete the file download.rdf from the path: C:\Documents and Settings\[your user name]\Application Data\Mozilla\Firefox\Profiles\vlcl3pr1.default\ (Assuming Windows XP also).

Now with Firefox 4.0 and Windows 7, the "download.rdf" file does not exist. I specifically looked at C:\Users\[your user name]\AppData\Roaming\Mozilla\Firefox\Profiles\vhhpucf5.default only two rdf files were "localstore" and "mimetypes" I plan to try deleting "localstore" and see if that works.

UPDATE: deleting "localstore" made no difference. I thought you could drag and drop the image, but that fails also.

The work around is that the image is saved as an "html" when in fact it is the image. You can change the extension to "jpg" (be sure to note the extension as you are trying to save the file).