I feel compelled to complain: the statement that recent observations
rule out merging neutron stars as sources of gamma-ray bursts is
utterly false, even though it is popular enough to make it to
BATSE press releases.
The idea behind the statement is as follows: 
     "if you smack two neutron
      stars together, or have a neutron star be gobbled up by a black hole,
      a lot of energy is released, enough for a gamma-ray burst at a
      cosmological distance. But, so the reasoning continues, this energy 
      is released below a lot of matter, so the radiation becomes
      thermalized and you expect to see roughly a blackbody spectrum.
      The observed spectra are strongly non-thermal, so this model must
      be wrong."
As so often, the fault lies with the imagination of the person who
was trying to prove the model wrong rather than with the model. It
may be that the initial energy release is not seen as a gamma-ray
burst, but the 'fireball' of energy and matter that is created
may spew out a relativistic flow. When this slams into the surrounding 
medium, a strong flux of non-thermal gamma rays results, which may
carry off a substantial fraction of the initial total energy. All
this is not my idea: it is in a series of papers by Martin Rees,
Peter Meszaros (sorry for the missing accents:-) and co-workers.
It is certainly not a complete model, but it may well be the best one
around (summing over all proposed distance scales). An alternative
proposal for what creates the initial fireball, by the way, is the 
so-called 'failed supernovae' scenario by Stan Woosley, in which
a very massive star at the end of its life collapses to a black
hole. If the stellar core was rotating, part of the infalling matter
will be temporarily halted because it is supported by centrifugal
force, and form a very dense neutron torus that accretes onto the
black hole. This beast may spew out a jet along the rotation axis,
which again constitutes relativistic flow. The rate of such
events may be much higher than that of neutron star mergers,
but the flux may be more strongly beamed, so that the net rate
of bursts observed on Earth stays the same between the two
scenarios, but the energy released per event can be a lot less
in the failed supernova scenario.

On another note: I do believe that the distance scale must 
ultimately be resolved via some classical astronomical method
such as finding counterparts to the bursts at other wavelengths,
or finding a definitive signature of some known class of
objects in the distribution of positions and fluxes. Theorists
have historically not been too successfull in finding the
distance of any object by proving that there is only one
possible way in which the object can work, and therefore
it *must* be so-and-so.