Hey Spence, you look new so I'm gonna be as gentle as I can.
Have you tried the search button, or browsed the forum here a bit? You'll find that not only have users posted fixes to this problem, but we've actually got active threads just below yours on this very subject
I'll save you some time, I've got a fix on my Installer Repo, just follow the link in my Signature for all the details. The fix you're after is called, FIX: IaD Wallpaper App.
My issue is not with Wallpaper app, it works fine with me. My issue is that even using the wallpapers that are installed on the iPhone, I cannot switch my current wallpaper, it goes through the same process.... I select a picture/wallpaper, choose to "set as wallpaper", but nothing happens. I'm stumped on this one and I've searched the forum and can't find any solution.
I have a suspicion your LockBackground.png was possibly left without the correct permissions for the user "mobile" to do anything to it, as it's previous owner in 1.1.2 would have been "root".
I don't know if you restored your backup of your iTunes profile after updating your iPhone to 1.1.3, but this sort of "quirk" is common and its recommended to set up a "New" profile with iTunes after each major firmware upgrade and jailbreak process.
That said, I think iSwitcher removed the wallpaper for you because its already running under "root" and the LockBackground.png was still owned by that username.
This fix should work for anyone else experiencing this problem, however if you're a little more saavy with an FTP client or Terminal, you could just manually delete the file or change its permissions to 777 so that any app/owner can alter it.