Mexico's first problem started with its infrastructure. It set up inward facing economic policy, where instead of importing goods from other countries it created institutions to create those products domestically, and set high tariffs on imports of similar goods produced abroad. This infrastructure became entrenched in the socio-economic structure. Then, in the 1970's, as the price of oil was shooting to record levels, there was a massive discovery of oil in Mexico. This brought massive amounts of foreign capital into Mexico, which spurred intense growth of firms. This in turn required more money, this time in the form of foreign loans, leading to a large debt in the form of U.S. dollars. 

In July 1982, the Mexican gov't realized it wouldn't be able to pay its debts, and sent a delegation to the U.S. to inform the gov't that they were insolvent. This shattered the foreign confidence in Mexico and this loss of confidence spread to other Latin American countries that also carried debts in dollars. This led to a flight of foreign capital, leaving other Latin American countries insolvent as well, even the ones that were responsibly managed.

They can:

1. Stabilize Exchange Rate: Pegging a currency to another, or using the volatility of the exchange rate.

2. Capital Mobility: 

3. Independent Monetary Policy: Process by which the monetary authority of a country can control the money supply. 

A country can only choose 2 out of the 3, creating a trilemma

Krugman paints a picture in which developing countries in crisis are forced to choose between combating a recession (internal balance) or restoring international confidence  in their economy (external balance).  What is the basis of this dilemma and what are the tradeoffs?

CDS's (credit default swaps) were a financial instrument that acted as an insurance policy against the failure of CDO's. Lewis said it was like taking out a high-paying fire insurance policy on someone else's building when the building was already on fire. People that bought credit default swaps were betting against CDO's. If the CDO failed, the person that sold the CDS had to pay the person that bought it. Until then, CDS buyers paid a premium to the insurer. 

They contributed to the current situation as follows. CDS allow credit creation for two reasons: protection sellers may be unregulated (don't have to put up capital against the risks they wirte) and where they are regulated, capital requirements against exposures can be lower, especially when the protection is written against very highly rated risk. Risk on mortgage pools got higher ratings because of faulty assumptions about individual borrower creditworthiness / house price movements / house price correlations. 

So when house prices all collapsed together and borrowers walked away, protection sellers found they didn't have enough capital to cover the sharp, simultaneous increased likelihood of having to honour the contracts they'd written. Since everyone was the same way round, they couldn't lay off the risk.

Started in Thailand (1997-98). The huge trade imbalance and the disappointment in export revenues undermined investor's confidence in Thailand's ability to keep its exchange rate pegged to the dollar. People began expecting a devaluation and didn't want to be holding the Thai baht when it came. Also, much of the debt that Thailand was holding came from the international markets, and had to be paid back in dollars. This raised the cost of devaluation because Thai financial institutions raised revenue in baht, but owed a fixed amount of dollars. Any change in investor confidence could undermine the entire economy. 

What is less certain is how the crisis spread to the rest of the Asian countries. One theory is that when investors started losing confidence in Thailand, they started looking at their other investments in the area and worrying about those. They thought that if Thailand could fall, why couldn't these other countries. Unfortunately, while this could have been avoided, there was a self fulfilling prophecy where investors lost confidence in Asian markets, thus engaging in capital flight to quality and actually causing the crisis that they feared was coming.

It started with businesses starting to figure out how to use information technology in the 90's. This lifted profits and helped control inflation, contributing to the good economic news under Greenspan. The Feds would normally raise interest rates to control bubbles and over-inflation. It is speculated that if employment goes below 5% there will be accelerated inflation, and therefore the normal reaction from the Fed would be to raise interest rates. Greenspan however refused to do so because "acceleration of productivity growth might have changed the historic relationship between low unemployment and accelerating inflation. He was right, unemployment fell to record levels and inflation remained normal.

Greenspan saw the stock bubble and warned against it but didn't do anything to curve it, instead he waited for the bubble to burst. He was worried about the possibility of "corrosive deflation" so he kept cutting rates, eventually bringing the Federal Funds rate to just 1 percent. When monetary policy didn't get traction, the housing market did. Greenspan ended up successfully replacing the stock bubble with the housing bubble. He did not believe a major decline in housing prices was likely. 

Fannie and Freddie are Government Sponsored Enterprises (GSEs). This means they are privately owned, but receive support from the Federal Government, and assume some public responsibilities. 

The GSEs provide a secondary market in home mortgages, puchasing mortgages from the lenders who originate them. As part of their public responsibility, they GSEs commit to purchase specified numbers of subprime loans, because without them, there would not be much subprime lending. This puts them at risk, and if they have a crisis like the one in 07-08, the taxpayer is on the hook to bail them out.