At first in my research, I discovered TFS is (somewhere...RegProxyFileCache.xml I think) configured to look for WSS (Sharepoint) Admin at port 17012. Some folks identified a second install of WSS leads to the incorrect port for WSS...thus causing a TFS project creation error. This was not the case for me.
Finally, upon highly scrutinizing the project creation log file, I found an inner, inner, inner exception reading:
Exception Message: The request failed with HTTP status 403: Forbidden.Checking IIS on the TFS instance for the "Sharepoint Central Administration" site, I opened the Directory Security tab. Sure enough, the "IP address and domain name restrictions" option was set to default deny and only granted to localhost (127.0.0.1). Ugh. Security. ;-)
To resolve, I simply set the option to default grant. Project creation successful! I hope this helps someone avoid this issue.