Timmy G:I'm also having this problem; for me no keyboard input is accepted in the textbox or password box control. I've tried setting windowless=false but that makes the settings and close buttons that appear for all gadgets disappear so that's a dead end too. Setting the size of the object element in the html did not fix the problem either.
I was having this problem as well. The solution I found was to have the Silverlight app size set smaller than the size of the gadget as a whole. The problem is (I think) one of competing interactions. The Silverlight app doesn't inform the gadget that the user has moused over the Silverlight portion of the gadget. So what you need to do is allow the user some space that isn't taken up by a Silverlight app. I used a 5px difference, and that worked pretty well.
The other option is to host your Silverlight app online and put it into the html page via an <iframe />. That solution is pretty seamless, but it also means that the user needs to be connected to the internet when they boot their machine... otherwise the gadget won't load.
If this is helping at all, you can download my silverlight gadget here:
http://www.designerwpf.com/2008/12/03/updated-silverlight-color-picker-gadget/
I also talk more about this over here:
http://www.designerwpf.com/2008/12/03/tips-for-creating-a-silverlight-2-gadget-for-vista/
I hope that helps.