Web Sharing does not work with FileVault?
I'm assuming you aren't using Lion, since your description sounds more like FileVault 1 (through Snow Leopard) than FileVault 2 (Lion).

FileVault 1 protects the entire home folder, with encryption when you aren't logged in and permissions when you are. In order to get to files in your Sites folder, the web server process would have to go through your home folder -- since it can't get into your home folder, it also can't get at anything inside it, so the permissions on your Sites folder are irrelevant.  (I'd recommend setting the perms on Sites back to 755, though -- 777 is just a bad idea.)

As a result of this, ~/Sites is pretty much useless in FileVault accounts.  Same with ~/Public -- normally, it's for sharing files both locally and (if the services are enabled) over AFP and/or SMB, but with FV it's not reachable.

But you do have an alternative: the top level web directory, /Library/WebServer/Documents.  Just replace the default files with your own and you should be good to go.