In continuation of my monologue: I tried placing the machine key entry inside the <system.web></system.web> of the root web.config file located in "%SystemRoot%\Microsoft.NET\Framework64\v2.0.50727\CONFIG\web.config" and rebooting. Still no luck. The machine key looks like this...

Good news. I found on some other forums the idea of running "logman.exe -ets" before attempting the authentication from localhost and I got back a much more verbose error of: "you must specify a non-autogenerated machine key to store passwords in the encrypted format" So this is good...