SharePoint sites keep asking for authentication and credentials don't work on your dev machine

So I set up a development VM, nice and clean on a fresh install of Windows Server 2003. I used the VM for a number of months to do development without problems. Then one day, I start it up and suddenly I'm being prompted for credentials each time I try to access a SharePoint site. Whats worse is that the credentials don't work and I keep getting re-promted. Eventually I get an access denied page. Another symptom wass I was unable to reset the App Pools for the web application and kept recieving an Access Denied error. The wierd part was the web applications were experiencing these symptoms when trying to browse them locally, but from a remote computer, they were working just fine.

Nothing changed on my machine so the obvious reason must be a windows update. Searching online, I found the following link which fixed the problem right away.

http://support.microsoft.com/kb/896861

The issue occurs if you use loopback address mapping. Maybe you changed the hosts file on the local machine in order to set up a dummy domain for development. This used to work, but a recent windows update caused such a setu pto stop working and experience the above symptoms.