Url: http://realise-systems.net/blog/jsaull/archive/…
This nasty problem confused the heck out of me.  Luckily I wasn’t the only one.  James Saull ran into it on a machine with SharePoint installed (same as me).  Removing the virtual directory (or whole Virtual Server) from the SharePoint Application Pool got me 1/2 way there.  Last trick (as James mentioned in his blog), was to add the following to my web.config file:

<trust level="Full" originUrl="" />

Wacked!