You're asking the wrong question. For the problem you're having, turning that option on would only make the problem worse.
As for the root cause, this one's a bit baffling. I've never seen an issue like this before. Some troubleshooting steps to try:
1. Can you open the image you're trying to use as a desktop background in Preview? If not, the image is corrupted.
2. Is the folder the image is located in readable to the system? Check the permissions from the Get Info window, if you suspect this might not be the case.
3. Something might be screwed up elsewhere - say, you have a bad preference file.