WebClient generates (401) Unauthorized error

Apparently the OS you are running on matters, as the default encryption has changed between OSes. This blog has more details: http://ferozedaud.blogspot.com/2009/10/ntlm-auth-fails-with.html

This has apparently also been discussed on stackoverflow here: 407 Authentication required - no challenge sent

I would suggest read the blog first as the distilled knowledge is there.