pathauto_entity_entity_insert causes file uploads to fail with File Entity

Spent 7 hours hunting this down yesterday when I found out what was causing it.

I have a site using Media, File Entity, and Pathauto Entity. What started was occurring was when I would go to upload a theme logo, or use Media Browser to insert a file into the WYSIWYG, the upload was failing with:

"The specified file could not be copied, because no file by that name exists. Please check that you supplied the correct filename."

#1538796: file_unmanged_copy() fails with "The specified file could not be copied, because no file by that name exists"

/**
 * Implements hook_entity_insert().
 */
function pathauto_entity_entity_insert($entity, $entity_type) {
  // @todo Remove the next line when http://drupal.org/node/1025870 is fixed.
  unset($entity->uri);
  pathauto_entity_update_alias($entity_type, $entity, 'insert');
}

The problem is that with File Entity, any uploaded file is treated like an entity and thus is fed through this function. Unsetting the URI causes a lot of issues with file inc because it can't find it.

Commenting out the unset fixed this error for me short term- without it uploading files to a website is completely broken.

I think 'file' can be excluded as an entity type like node and user are, though I have not had a chance to debug further.