Very Interesting problem and solution.

Dug around a bit more and found that the Transaction Log file for the database was full.

Clearing this resolved the problem. Hope this might help someone else.

Pat

Not sure if your problems are still there, but i had similar issues.  I checked & double checked the machine keys and all other settings in my web.config.  I even copied the source package over the top instead of the upgrade package.  But the problem persisted.  I resolved my problem eventually by copying the highlighted settings from the old web.config to the new.  I think the one that did the trick was "applicationName"

<add name="AspNetSqlMembershipProvider"
     type="System.Web.Security.SqlMembershipProvider"
      connectionStringName="SiteSqlServer"
       enablePasswordRetrieval="true"
       enablePasswordReset="true"
       requiresQuestionAndAnswer="false"
       minRequiredPasswordLength="7" (You may need to change this setting)
       minRequiredNonalphanumericCharacters="0" (You may need to change this setting)
       requiresUniqueEmail="false"
       passwordFormat="Encrypted"
       applicationName="YourApplication" (You may need to change this setting)
       description="Stores and retrieves membership data from the local Microsoft SQL Server database" />
            </providers>


Hope this helps.
Cheers
John