Thinking about this a little bit more, I suspect the 6n138 is having problems (among other things). Again, it doesn't make sense to me that midi out doesn't work either, but maybe there's more than one issue at play.
If I understand correctly, I should NOT be able to program the arduino when it's in any mode other than programmer (with all leds on). However, I am able to program it regardless of which mode I'm in. If I understand the code and schematic correctly, the 6n138 vcc is tied to arduino I/O pin 4 so we can control the power on the fly. I suspect that the opto is not getting power correctly. I will attempt to connect 6n138's vcc directly to the arduino's vcc and see if I get any better results from that.
Other than that, I am at a bit of a loss here. Help me Jazzmarazz, you're my only hope!