You have the wrong input channel selected, many sound cards have an input channel called 'Stereo Mix' which is just an input of all the output sound.
Go to Volume Control (Start > Run > sndvol32) and go to Options > Properties. Select 'Recording'. Be sure 'Microphone' is selected below and select OK.
Now you should see all of your recording devices, make sure 'Microsoft' has 'Select' enabled.
Good Luck!