The Federal Housing Adminstration's insurance program is materially undercapitalized and will require a capital infusion of $50 billion to $100 billion in the next few years even if housing markets do not deteriorate further. Joseph Gyourko, a real estate and finance professor at the University of Pennsylvania Wharton School, concluded that in his just-released study: "Is the FHA the Next Housing Bailout?" His answer? "Yes" "That range is based solely on correcting errors in estimation strategy and techniques, as well as data organization," he says. "If the economy and housing markets deteriorate unexpectedly, we need to be ready to infuse even more capital into the (FHA) Mutual Mortgage Insurance Fund." Describing the present state of the fund as precarious, Gyourko says for the past two years, the nation's 77-year-old insurer has been in violation of its capital reserve regulation. To comply with this rule would require a $12 billion capital infusion in fiscal year 2010, his research found, and that presumes future losses are not being underestimated by FHA. The FHA has expanded since 2007, and the combination of increasing leverage at the entity level and among the homeowners being insured — many with negative equity in their homes — has made FHA a very risky proposition for taxpayers, who bear the risk if the expansion strategy does not work out, according to Gyourko. The Wall Street Journal recently reported that economists from New York University and the Federal Reserve Bank of New York issued a paper last year warning of the growing likelihood the FHA would need a taxpayer bailout. FHA officials disputed some of that report's findings. The FHA insures lenders against defaults and is funded through the mortgage-insurance premiums it collects. It backs about one-third of all new mortgages originated for home purchases. Gyourko's study was commissioned by the American Enterprise Institute, a conservative think tank. He says the FHA's independent outside reviewer, Integrated Financial Engineering, is underestimating the federal agency's risk of insolvency because of a decision to down-weight the influence of borrowers' credit risk in FHA mortgage pools. And as a result, the likelihood of a borrower in the FHA insurance pool defaulting is underestimated by 50%. Gyourko claims the auditor's risk analysis doesn't factor in unemployment, risk associated with borrowers who used gifts from taxpayers to fund their down payments and underestimated negative equity risk. Another problem is that refinancings are treated as if there has been a full prepayment with no further default risk to FHA, which Gyourko says is "clearly incorrect, as the costs of a potential default remain because the new loan is insured by FHA." However, the Ivy League professor says there is little reason to expect an extreme liquidity crisis for the fund in the next couple of years, which would require immediate losses high enough to deplete the roughly $30 billion in liquid capital resources presently available to the fund. "That would take a huge leap in defaults and almost immediate losses that no one is anticipating. The future losses … will happen over a period of many years, not in any one single year," he says. "That provides only small comfort, as one can envision a confluence of events leading to a liquidity crisis over the medium term." Considering that the FHA is operating a $1 trillion-plus business platform and its liquid reserves are only 3% of potential liabilities, Gyourko warns that it would only takes a few years of multibillion-dollar cash outflows to wipe out $30 billion in liquidity. "That a reasonable person should have even the remotest worry about a liquidity problem at FHA within the next few years highlights how risky the current situation is, but it is inevitable when one is running such a highly leveraged operation. I would expect those worries to arise sooner rather than later if the economy and housing markets do not recover fairly quickly," Gyourko said. Write to Justin T. Hilley. Follow him on Twitter @JustinHilley.