I found out that it works for top-level folders only. If you want to make a new playlist from a sub-folder, move the sub-folder to the top-level first (by drag and dropping it on the PLAYLISTS heading).

I wish you could quick-create new playlists under a folder by selecting songs in the browser and dragging them to a folder. unfortunately you have to create a playlist under the main tree first, and then drag it up to the folder.

When I click on the folder name, it shows me all the items in the enclosed playlists, so I can then select all (apple-a) and create a new playlist from selection (apple-shift-n). My quick test shows this will let you create a playlist from a nested sub-folder.