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It dilutes link juice--a subdomain is viewed as a separate site. Putting your blog as a subdirectory helps to build the authority of your main domain.

Yes, this is it. If you host your blog on blog.mydomain.com your main site won't receive the full benefit of the inbound links.

Side note: sometimes this is desired. For instance, one domain can only occupy 2 slots in a SERP, but each subdomain can take 2 more slots. So in theory, you could take up an entire results page with your main domain and 4 subdomains.

I'm not seeing that Matt is really admitting that there's anything wrong with them. http://www.mattcutts.com/blog/subdomains-and-subdirectories/

they get treated as separate sites so your raking gets diluted