Microsoft just told its shareholders it is taking a charge of more than a billion dollars, somewhere north of $1.05 billion, to extend the Xbox 360 warranty to three years. The reason is the three flashing red lights that a frankly alarming number of these consoles greet their owners with before dying. That is the official admission. Everyone who owns a 360 has known it for months.

The Red Ring of Death is a general hardware failure, the kind that traces back to an overheating graphics chip cooking its own solder joints loose. Microsoft is not publishing a failure rate, which tells you plenty, and the numbers traded around retail and repair forums are bad enough that I half-refuse to print them. Peter Moore signed an open letter owning it, and the company is swallowing the warranty cost because the only thing more expensive than fixing a million consoles is pretending they are fine. The full-year head start Microsoft bought over Sony is now partly being spent on shipping people refurbished hardware.

And here is the part that should keep Sony’s executives awake: while Microsoft eats a billion dollars in repairs, the console actually winning 2007 is the cheap one with the waggle remote. You cannot find a Wii. Eight months after launch it is still sold out, still scalped above retail, and Wii Sports has turned people who have never touched a controller into living-room bowlers. Nintendo is outselling the entire room and physically cannot build them fast enough.

The PlayStation 3, meanwhile, the $599 monster with the best silicon in the building, is the one nobody is panic-buying. Sony is under real pressure to cut the price, the exclusive lineup is still thin, and even winning the Blu-ray format war has not translated into people choosing the console. Bringing the most powerful machine to the fight and sitting in last place is not where Sony expected to be a year ago.

I am not going to run the full Blu-ray versus HD DVD autopsy here, that disc war deserves its own post and it is not done playing out. What grabs me is how thoroughly this generation has scrambled everyone’s assumptions. Microsoft bought a year’s lead and is spending it on solder. Sony brought the strongest hardware and landed dead last. Nintendo brought the weakest box on paper and cannot keep it on a shelf.

The Red Ring is going to cost Microsoft well over a billion dollars and a chunk of goodwill, but the uncomfortable truth underneath it is that people keep buying replacement 360s anyway. The games and Xbox Live are sticky enough that a failure rate which would have flat-out killed a weaker brand registers as an expensive embarrassment instead of a death sentence. That is the moat Halo and Live quietly dug. Sony’s real nightmare is that a competitor’s console literally breaking is not even the scariest thing on the board right now. The Wii is.

The Console War, in Order