1. For this example, we will make a 1024 x 768 pixel wallpaper. For the sake of saving space here, the samples you see will be of a smaller resolution. So make a new document and then we will move on to selecting pictures.

2. Obviously, since you're working with a large canvas, you would want to use high quality images. I used these two pictures of Ada Choi and cleaned up parts of her skin that were too scratchy with the blur tool. Note that this doesn't work in every case and depends on the quality of the original image. Generally, the less noise there is, the better.
Picture One and Picture Two

3. Paste the two images onto your wallpaper canvas. What color should you choose for the background? Usually I use the eyedropper tool to select a color from the images and fill the background with it. In this case, I chose #98B4B7 as the background color for a new layer that I dragged to the bottom of the palette. Most of the time I do not like using light backgrounds as it is difficult for effects to show up or blend properly later on.

4. Position the pictures so that there is balance in the wallpaper, meaning putting one directly on top of the other or putting them exactly side by side will probably not be the best idea. This is what I came up with (I lowered the opacity of the first image so you can see the second as well):


5. Time for the blending! Of course, there are different ways you can blend. In this tutorial I will go over three methods. First, for each picture layer, add a vector mask (it's the icon of a rectangle with a circle in the center at the bottom of your layer palette). Select the vector mask, press D to go back to default colors, and grab your gradient tool. Change the settings to Linear Gradient (first icon to the right of the gradient bar) and the mode to Difference. Click and hold on the picture, dragging the gradient across to the other end of the image. Release and you will see that that part of the image has now faded out. This is blending with layer masks. Personally, I prefer this method because if I make a mistake, the image itself is not gone - rather, the layer mask was changed and can be changed back with either a black or white brush (black erases, white brings it back).


6. The other method you can use is a soft large eraser brush, around 300px and start erasing the edges. I do not use this method but something similar to it, which is selecting the layer mask and using a black brush to erase edges of the image. This is almost the same as using the eraser tool, but like I said before I can edit the blending much easier with a layer mask.
7. After blending the images into each other and into the background, you should get something like the following. (Don't worry if it doesn't look the way you wanted at first because blending takes practice!)


8. The white backgrounds of the images stand out in an unflattering shape against the darker blue-green background. To fix this, take the gradient tool again and make a new layer behind the layers with the pictures. Instead of Linear Gradient, make it Radial Gradient this time (it's to the right of Linear). Change the gradient colors from white to #98B4B7 (your background color). Click and hold on the right side of your wallpaper and drag it to the left and then release. Now that weird weird made by blending your images is blended into a softer-looking circular blurry thing (synonyms, anyone?).


9. The background still looks plain, so I'm going to add a cloudy textureby resurgere in a new layer behind the images. First I'm going to change the pale colors so it matches the blue-green color by going to Ctrl + B and adjusting the color balance. Just play around with the settings until you get something you like.


10. Looking better now, but I don't want the clouds to fill the entire background since the subject is on the right and that's where I want the focus to be. So time to introduce the third blending method. Grab your lasso tool and make the feather 100px anti-alias (look at the top to find settings). Now draw a blob around the image on the cloud layer like so and release to see the dotted lines.


11. Without deselecting the blob, add a vector mask and you will notice that the clouds outside of the blob have more or less faded away. This is the lasso and feather way of blending. Again, you can use a soft, large black brush on the vector mask to remove any unwanted clouds.


12. Now we add a bit of "effects" to make the graphic pop a bit more. What I did was simply use a fractal I made in a new layer behind the images and above the clouds and set the blending mode to 100% Screen. As you did with the clouds layer, adjust the colors here so it matches your graphic. Use any type of blending you want to remove parts of the fractal that may be too distracting or cover the subject. Here is what I got:


13. Merge all visible layers. The graphic looks kinda of washed out right now. Go to Image > Adjustments > Auto Contrast for some contrast. And just because I wanted the graphic to be softer, I went to Filter > Blur > Gausian Blur and set it to a 30-pixel radius. Then with Shift + Ctrl + F, I faded the blur with 40% Screen and did another Auto Contrast.


14. For the finishing touch, I added black text and set the blending mode to 100% Overlay then merged all visible layers. And that's how I make a simple wallpaper. :) Finished result!