IIS7 returning 400 bad request on GET request

With Failed Request Tracing, you need to setup the rule, but as a separate step you must turn it on. In the Failed Request Tracing, check the Action pane on the right, that will have an option to enable it. That's my guess as to why the tracing isn't working.

My recommendation on any configuration in IIS7 where you have 1 site per app pool, or when all sites trust each other and the sites are stable, is to set Anonymous authentication to use the identity of the app pool. That gives you one less user to deal with. Then make sure that the app pool identity is granted permission on disk.

You mention that it doesn't work in the subfolder. It is possible to have different permissions or a different app pool used for a sub-application. Double check the app pool being used, and anonymous auth settings.

Finally, use Process Monitor as Colin suggested. Get it from www.sysinternals.com. It's free, safe to run on a production server and you'll figure it out in under 10 minutes. That will tell you exactly which user is denied access to which folder (or registry key).

Did you check this article ASN1 bad tag value met.