Yes, it's true the image button is inactive, but you don't need to use it. Just right click while you are typing in the editor and a menu will appear, like this:
Select Insert Image, then "from the Web", then paste in the url of the image.
Just testing:
Plastic Duck, above, was done by toggling the editor into HTML mode and pasting in the text from the "HTML Code" field in Photobucket.
This picture above was done by right clicking, selecting insert image and pasting in the "Direct Link" field from Photobucket.
This picture of Philip and Cory above was done by toggling into HTML mode and pasting in Photobucket's HTML Thumb field's text. It's a shame we can't just do a "Paste in HTML" in the full editor; it can be confusing and error prone trying to find the right place in the HTML when you only use it once every year or two.
Toggling into HTML mode and pasting in Photobucket's Flash Code field did not work.
I tried inserting a table and then inserting images into the table and that did not work.
I might as well try uploading one:
Hmm, appears we can't upload.