When working with the Active Directory module on a localhost machine or with a site that does not have public DNS setup, you need to follow the steps described here, http://support.microsoft.com/kb/896861, to get passed the Windows Authentication error. The solution under Method 1 worked for me.
I’ve copied the information into my post in case Microsoft ever takes down that page.
Method 1: Specify host names (Preferred method if NTLM authentication is desired)
To specify the host names that are mapped to the loopback address and can connect to Web sites on your computer, follow these steps:
- Click Start, click Run, type regedit, and then click OK.
- In Registry Editor, locate and then click the following registry key:
- Right-click MSV1_0, point to New, and then click Multi-String Value.
- Type BackConnectionHostNames, and then press ENTER.
- Right-click BackConnectionHostNames, and then click Modify.
- In the Value data box, type the host name or the host names for the sites that are on the local computer, and then clickOK.
- Quit Registry Editor, and then restart the IISAdmin service.