M$ could have easily gotten away with some other lower-capacity solution (generally speaking, from end user's standpoint the HDD is for savegames only, right?), but they didn't. And I think they had some rather compelling reasons to do so.
1. You don't expect your desktop HDD to fail within 2 years of purchase, do you? You don't expect your laptop drive to fail within 3 years either, despite a much heavier abuse vibration-, shock- and temperature- wise. So, why would you expect your console HDD to fail sooner than you'll throw out the console itself or donate it to some poor neighbors' kids? I don't think XBox will be of any meaningful value as a game console 3 years from now - but hey, that's just my personal opinion, right? It is based on the advances in graphics industry, however, so it's more of an educated guess...
2. Given all the .NET buzz (or rather "given M$'s commitment to making money out of everything, including thin air"), I wouldn't be surprised if some time from now M$ would release some form of software upgrade (for some admirable sum of money, of course, in best M$ traditions!) that would turn XBox into something much more than just a console. How about point-n-click email solution as an added value (based on M$ Hotmail, of course) ? How about an internet browser suddenly becoming available to an average Joe, without ever forcing him to use that intimidating "computer thang" (heavily depending on M$ portals, of course) ? Oh yes, people, I think Billy the Kid has some rather interesting ideas regarding XBox future that may actually rely on having a working HDD in the box! So, chances are, Billy will do his best to make sure that HDD is still working - selecting the right model and brand may easily do [a part of the] trick...
3. Finally, as it is, XBox packs pretty much everything M$ HomeStation should eventually have, making HomeStation nothing but a slightly beefed up and/or modified XBox... As in "evolutionary design". As in "saving money". As in "beta-testing M$-style". (actually this is sort of a counter-argument, but I'll list it anyway to preserve the full picture...)
In a word, I think HDD in a console in not too bad an idea, even from the consumer's standpoint - at least HDD in a very specific console manufactured by one very specific company with very large appetites and a proven ability to bend the market to suite its very specific need - to create revenues...