TLDR: RTFM (http://striderweb.com/wp-content/multiblog/multiblog-readme.htm#permalinks)

I had problems with permalinks and Virtual Multiblog (yet another linky), basically that for every wordpress instance I added I would have to add another set of permalink-related Apache Rewrite rules to prevent individual entries 404-ing. This was fragile and prone to failure. Fortunately, there is a Proper Way To Do It:

RewriteEngine On
RewriteCond %{REQUESTURI} (/blog|/news)?/
RewriteCond %{REQUEST
FILENAME} !-f
RewriteCond %{REQUEST_FILENAME} !-d
RewriteRule . %1/index.php [L]

 

From the readme. Lovely.