After the automatic update to Windows Live Messenger 8.1.0178.00 it changed my screen resolution to 640 x 480, True Color (32 bit) 60 Hertz.  I then change the settings back to 1024 x 768, which is ok UNTIL I reboot where upon it reverts back to 640 x 480.
I have installed the latest drivers - ATI Radeon 9600 series.
If I leave Messenger uninstalled everything is OK.

What is going on here?

what Windows OS do you have ?  by rights a IM client cannot do that what you have claimed
check for a Virus, sounds like it could well be a Virus installed into Messenger itself,

Window XP Home Edition.
I have Norton anti virus and firewall
Windows defender
Spybot Search & Destroy
Adaware personal
All run regularly manually and automatically.

I have done the following to rectify the situation:

Uninstalled Windows Live via Add/Remove
Deleted MSN Messenger directory from Program Files
Cleared all files from Temp directories
Deleted every thing from Internet Options
Emptied Recycle bin
Run Disk Clean up and Defrag
Run Norton system works WinDoctor
Deleted the IconCache.db file (worth a try)
Increased the Max Icon Cache size in registry (again worth a try)
Installed previous Messenger version 7.5
Updated video driver files

The reinstall of version 7.5 and a fresh complete download and install of 8.1 were downloaded using another machine.

I do not have any Messenger third party ware installed.

At present I do not have Messenger installed and every thing is OK.

I have a faint suspicion a complete reformat and install may be needed as I have noticed that things have been slowing down over the past few months ever since I had to replace the power supply.