The Bani Group Inc.

The Federal Housing Administration announced that its reserves might not be able to cover projected losses, raising the prospect that the agency could ask for a taxpayer injection for the first time in its 78-year history. Here’s a look at the issue:

The FHA reported on Friday that its annual audit shows that the agency doesn’t have enough in reserve to cover expected losses, leading to a $16.3 billion net worth deficit. Is the FHA broke?

The FHA had reserves of $30.4 billion as of Sept. 30, according to estimates by its independent actuary. The report looks at what would happen if the FHA didn’t write any new business and then it makes assumptions about home prices and interest rates, projecting how much money the FHA would have to pay to cover any losses over the 30-year life of those loans. The report says that the current loans, under a base case economic scenario, will lose around $46.7 billion. That means the FHA isn’t out of money today, but they won’t have enough money to pay those claims.

“What it’s saying is that if you ended the FHA program today, they would need a Treasury draw. They do not have enough capital,” said Thomas Lawler, an independent housing economist in Leesburg, Va.

There’s a lot of talk about an FHA “bailout”? How does the government bail out its own agency?

The government doesn’t actually have to go to Congress and ask for money. The FHA has what’s known as “permanent and indefinite” budget authority, meaning that it can simply receive a direct appropriation from Treasury to cover any losses. The bailout term arises from the fact that this particular agency has never had to rely on taxpayer money to cover losses.

When could that happen?

The White House’s Office of Management and Budget will produce its own forecast of the FHA’s finances when it releases the president’s annual budget next February. At some point later in the year, and no later than September, the FHA could submit a request to the Treasury to move money into its reserve accounts.

The FHA is required to have enough cash in its reserves to pay for anticipated losses, so even though the FHA has some $30 billion in reserves, it would have to take money from the Treasury if the OMB found that the FHA were expected to lose more money than whatever it had on hand.

Obama administration officials say that the agency will take steps to prevent any Treasury infusions. How is that possible?

The FHA could make a series of changes to charge more money for loans that it guarantees in a bid to boost revenues and increase the projected value of new business. It could also announce new legal settlements with banks, new changes in how it will handle a growing inventory of more than 730,000 defaulted mortgages, and other steps.

Will FHA loans become more expensive for borrowers?

Yes. The FHA will raise annual insurance premiums by 0.1 percentage point, following a series of earlier fee hikes. The FHA will also revamp its program so that borrowers will have to pay mortgage insurance over the life of their loan. Currently, borrowers no longer have to pay insurance after certain thresholds are met. For a 30-year fixed-rate loan, for example, annual fees aren’t collected after five years and after borrowers owe no more than 78% of their property’s value.

The FHA is also planning to revamp its reverse mortgage program, which could reduce the amount of money that seniors can borrow.

How did the FHA become such a big player in the market?

The agency didn’t relax its standards during the go-go days of the subprime bubble, and it lost market share to the private sector. But once the subprime market disintegrated in late 2007 and then when Fannie Mae and Freddie Mac tightened up their standards in 2008, the FHA faced a glut of new business—largely from borrowers and communities that had been served by the subprime mortgage market. It is likely to sustain huge losses on those mortgages.

The FHA was also shut out of many of the most overheated housing markets in 2006 and 2007 because of loan ceilings that varied by county. In Los Angeles County, for example, the FHA couldn’t guarantee loans that exceeded $362,790, at a time when many houses were selling for far more than that. In March 2008, Congress and the Bush administration raised those loan limits, allowing the FHA to reach a much larger share of the market.

The FHA has played a major role in the market since then because there is little private capital willing to make loans with down payments of just 3.5%. Officials in recent years have struggled with calibrating the balance between protecting taxpayers and keeping housing credit flowing, and that struggle is only going to become more acute amid rising calls now for the FHA to retrench.