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i have this problem to when trying to use wonderful looking pics i take with my phone but magically turn to crap when i use them as wallpaper.
As for the cropping rectangle that appears when you select an image for use with wallpaper, that rectangle never encompasses the entire image. at least it never does on my phone
By default, that rectangle will only encompass between 1/2 and 2/3 of the image, but you can drag a corner of it in order to make it fit the whole image...then you should see your native image as a background...hope this helps
Well that's just evil.