From this history, ISTM that WinFS was doomed as soon as they decided to build it on top of the "Mighty Mouse" embedded SQL Server. SQL Server is, by all accounts, a well-designed piece of software, but something doesn't become "platform layer" just because you say it is. I don't blame Microsoft's other BU's for not wanting to put what is essentially another application layer between their code and its persistent data.
On another note, the proposed client use cases 10-15 years later read as almost quaint. The vast majority of photo management these days happens on the web and in HTTP-using client applications, where sharing, not editing, is the killer feature. The right client bet was not to help users manage data on their own PCs, but to take over that responsibility for them. Through SkyDrive and other "cloud" capabilities, Microsoft can do that today, but imagine if they'd started 12 years ago. Facebook only exists because they got photo sharing "good enough"; there's no reason Microsoft couldn't have beaten them to it.