I was having trouble with my videos that I uploaded to youtube this week. They were getting pixelated. I found this link to a different version of their upload process and it worked perfectly:
That is so bad I doubt it had anything to do with what you uploaded. It's the same at 720p and 360p.
You say using a different uploader cured the problem but all the uploader does is transfer the file from your HDD to one on YT's server(s). What I think happened was the file was corrupted during the upload and uploading it again got it there without the corruption. It could be that the other uploader has better error detection / correction I guess.
I doubt it being WMV has much to do with this problem.
Thinking about it again and given that another upload of the same video cleared the problem I'm inclined to think the OP just struck a computer in YT's vast network with a wobbly WMV decoder. Each I frame seems to decode perfectly and then the difference frames get progressively worse until a new I frame comes along and all is good until it falls apart progressively again.
Certainly reducing the time between I frames during the encode can help but then again I've worked with WMV files with I frames minutes apart without problems getting a clean decode. Vegas didn't like it because it is forced to buffer so many frames but it was still clean.