It looks as though you are not going to get a reply to this so I will try to help even if I am far from an expert.
My guess is that the server on the remote machine is set up to only accept a login with secure public/private key encryption. This is a very convenient, secure and easy way of using ssh. There is an excellent explanation at http://www.steidler.net/uptime/archives/000391.html
If you do not want to use this method (and there is no need for encryption if it is just for two computers in the same location) you must reconfigure the sshd on the remote machine. Start by taking a look at /etc/ssh/sshd_config. Mine is listed below.
# Set this to 'yes' to enable PAM keyboard-interactive authentication
# Warning: enabling this may bypass the setting of 'PasswordAuthentication'
# no default banner path
# override default of no subsystems
Subsystem sftp /usr/lib/ssh/sftp-server