Published: Thursday, 12 Nov 2009 | 5:30 PM ET

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Capital reserves of the Federal Housing Administration have fallen well below legally required levels, due to significant losses on home loans made before this year, Housing and Urban Development Secretary Shaun Donovan said on Thursday.

The FHA has capital reserves equal to just 0.53 percent of the value of the thousands of outstanding U.S. home mortgages it insures, well below the 2 percent required by law and down sharply from last year's 3 percent, Donovan said, citing an independent actuarial study released on Thursday.

He warned that reserve levels could dip into negative territory if the U.S. economy turns sharply worse.

The capital reserve fund is a secondary, surplus fund set up by Congress in 1990 to provide an extra cushion for the FHA in times of economic distress. The fund contained $3.6 billion as of Sept. 30.

The FHA also maintains a separate financing account, which is used to pay for expected losses. The two accounts total $31 billion, or about 4.5 percent of outstanding loans. Last year, the two funds represented 6.4 percent of outstanding loans.

If the capital reserve fund falls below zero, FHA has the authority to get funded directly from the Treasury without having to ask Congress for more money.

"We haven't used the bailout word today because ... even if we were to go below zero, there is no extraordinary action that Congress or anyone else needs to take," said Donovan.

Donovan added that it was only in the most extreme forecast, such as 12.5 percent unemployment and severe home price declines, that FHA capital reserves could fall below zero.

He noted that private economists place about 1 percent odds that the U.S. economy would actually see such a severe downturn.

The FHA has guaranteed about a quarter of all U.S. home loans made this year and needs reserves as a cushion in the event of losses.

Donovan was careful to stress that all is not well with the FHA.

"I don't want to leave the impression that the reserves are adequate," he said, adding that he and FHA Commissioner David Stevens are committed to changing the way the agency does business to bring it to fiscal health.

"There are real risks to the FHA and we are aggressively addressing those real risks with real reforms," Stevens said in a statement.

The announcement was met with skepticism on Capitol Hill.

Rep. Scott Garrett, a New Jersey Republican and frequent critic of U.S. housing policy, pressed for the FHA to strengthen its fiscal health by raising the minimum down payment for borrowers from the current 3.5 percent.

"Americans should not continue to foot the bill for their government's failings," Garrett said in a prepared statement.

Donovan said the FHA was "actively looking" at raising the mortgage insurance premium borrowers pay on every loan, which would bolster reserves but could also cause a slowdown in the housing market as it would raise borrowing costs; he said no decision had been made.

The news comes on the heels of the third straight monthly decline in U.S. home foreclosures. RealtyTrac said foreclosures fell 3 percent in October to 332,292 U.S. properties, though that's still 19 percent higher than a year earlier.

The FHA last month announced a series of credit policy changes to help rebuild reserves.

Since about 80 percent of the FHA's business is with first-time home buyers, who typically make smaller down payments, the FHA's role in the housing market is widely seen as vital.

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