Interesting...I clicked the link and opened the Change Avatar dialog, clicked the Browse button, and I got the standard MS file browsing/search dialog window. That, and the message you got, make me think that you've got a setting that prevents the feature from connecting to and searching on your hard drive.
Have you had any browser updates recently? I know that back in the fall, there were updates from Microsoft, for Internet Explorer, that reset browser settings for some of my customers, and they couldn't run my company's application; they got browser errors. In their case, we had them restore browser defaults. Whether you're using IE or some other browser, I'd be curious to know if something has changed, since the last time you were able to do this.
Hopefully you and I have given some good specifics for the technical staff to diagnose this for you.