FEAR is ruling the financial markets. Billions of dollars have been lost in mortgage-related investments. The Federal Reserve worked madly over the weekend to engineer a takeover of Bear Stearns and avert a systemic meltdown. But the big fear remains. How low will house prices go?

If prices continue to fall, mortgage defaults will move well beyond the subprime sector. Trillions of dollars in losses for investors are not impossible. But that doesn’t mean they are inevitable.

In 1997, inflation-adjusted house prices were close to their average levels over the previous half-century. Only four years later, the price of the average home nationwide exceeded anything ever seen before in the United States. Prices continued to rise for another five years, peaking in 2006 at nearly twice the average price in 1997 (as can be seen on the graph on the bottom right, which is based on data collected by the Yale economist Robert Shiller). If house prices are heading back to the levels seen in 1997, then we are facing catastrophe.

But there are good reasons to believe that much of the increase in prices was a rational response to changes in fundamental factors like interest rates and supply. The deeper fundamentals continue to suggest strong housing prices for the future.

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Economy, Foreclosure Center, Mortgages and Loans, Real Estate Market financial markets, interest rates, loans, mortgage, mortgages, Real Estate Market