This happens if you dont have the Silverlight Debugger Attached to the Web project in your solution.
Right Click the Web Project and go to Web tab under properties. Please check the Silverligth Debugger as shown in the Image below, you will be able to Debug
Enable Debuggin on VS 2008 for Silverlight
This exception comes due to simple reason that there are MIME Types missing for your silverlight Application which gives you following exception in your IE,
Silverlight Object Exception
To reslove the same you simply need to add the MIME types to your WebSite on IIS. Select HTTP Headers Tab under the Properties. Click on MIME Types and add
.xaml application/xaml+xml
.xap application/octet-stream
You also need to enable the Content Expiration
Now your silverlight object will be loaded. If you still face problems try checking up on your permissions
