Fear is ruling the US 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 US. Prices continued to rise for another five years, peaking in 2006 at nearly twice the average price in 1997. 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.

Sure, speculation did run rampant toward the end of the housing boom. Prices will fall further, especially in the speculative developments built on the outskirts of the major cities.

Still, especially in coastal areas where zoning regulations have restricted the supply of land that developers can build on, house prices were driven up by increasing population, low interest rates and strong economic growth.

Several studies estimate that the average house prices of 2004 were close to fundamental levels, so we may see prices stabilise near that level.

Granted, a catastrophe is not impossible — it did happen in Japan. House prices shot up in Japan in the late 1980s, and by 1999 they had collapsed. But the Japanese run-up in home prices was faster and reached higher levels than the one in the US. In addition, the Japanese population at the time wasn’t growing, and today it’s shrinking.

There are two very real problems for the housing market: tougher credit conditions and slower growth. Here the US faces a self-fulfiling prophecy problem.

If the financial markets can predict where and when house prices will stabilise, then credit conditions can quickly return to normal, the economy can expand and house prices will indeed stabilise.

But if the financial markets remain uncertain about when the decline in house prices will end, then fear will tighten credit even further, which would strangle the housing market and generate even more fear.

The best way to overcome fear is to look at the long run. The typical homebuyer keeps a home for 10 years or more, so there is time for those who bought in 2005 and 2006 to weather the current decline in prices. Those who bought at the top are unlikely to see any windfalls from house appreciation, but they will not necessarily suffer from buyers’ remorse. The collapse of housing prices certainly feels painful, and for some homeowners, it will be. But the houses are still there, as good as ever. Most of the gains going up were paper gains, and most of the losses going down are paper losses.