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) -- The

Federal Housing Administration

, the government agency that has insured more than 30 million homes, would probably need a bailout if the economy keeps contracting, said Edward Pinto, a fellow at the American Enterprise Institute.

Recent changes to increase mortgage insurance premiums and improve underwriting standards are "baby steps" in the right direction, according to Pinto, but the health of the housing agency remains precarious.

"It will only take a run-of-the-mill recession in the next one to five years, and all of their projections will be thrown out of the window. They will face catastrophic losses," he said in an interview with


. "If the U.S. has a cold, the FHA gets pneumonia."

Pinto, who was a top official at Fannie Mae in the late 1980s, has been a long-time critic of the FHA, arguing that it has been irresponsible in its lending practices to working-class families and has racked up an extraordinarily high failure rate. His warning this time is more urgent as the U.S. economy unexpectedly shrank last quarter, hurt by a cut in defense spending and exports. A second quarter of the same would technically mean the U.S. is in a recession.

In a December


of 2.4 million loans insured by the FHA in 2009 and 2010, Pinto identifies 9,000 zip codes in which one in seven borrowers are projected to lose their homes.

"The government loves to say that the FHA has insured over 30 million homes over the last several decades. What they don't say is that more than 3 million FHA borrowers have lost their homes to foreclosure," he said.

The FHA declined to comment for this story.

Officials of the FHA have previously

disagreed with the conclusions of Pinto's study

, arguing that the vast majority of borrowers have succeeded and that the very mission of the FHA is to serve higher-risk borrowers who don't have access to private credit.

The FHA insures lenders against losses on mortgage loans that conform to their requirements. These loans are normally targeted at first-time home buyers and lower- to middle-income groups who can't afford a big down payment. FHA loans typically require a down payment as low as 3.5%.

The FHA has insured 34 million home loans since 1934, according to the HUD website.

The agency's market share zoomed in the aftermath of the crisis, when it stepped in to provide credit as private capital withdrew from the market. But in the process, the FHA took on risky loans that had a high default rate, as home prices steadily plummeted.

The FHA has taken steps to improve its default rate. It no longer backs loans where the seller finances the buyer's down payment, which it says was a leading cause for soured loans. It has also raised premiums and tightened underwriting standards.

Still, in November, the agency announced that it had a $16.3 billion shortfall in its insurance fund.

Last week, the agency said it would

raise premiums further

, increase the minimum down payment on jumbo loans and require tougher underwriting standards for loans where the credit score is less than 620.

"The premium increases are a step in the right direction, but the FHA is getting diminishing returns on the increases, with premiums already quite high," says Pinto.

Steps to tighten underwriting might not make much of a difference in the near term. Banks largely are not making loans to borrowers with a credit score of less than 620, anyway.

"The FHA will not get back to zero in terms of capital for at least three to five years. If there is a recession, all bets are off," says Pinto.

Still, some of those changes bode well for the future. "If the FHA won't price for risk, they should at least underwrite for risk," he says, adding that the new changes offered a glimmer of hope that underwriting standards were improving.

According to Pinto, the FHA charges the same premium for all borrowers regardless of credit score. That allows the agency to use the premiums from more creditworthy borrowers to cover the losses from risky ones. It also masks to the borrower the true risk he undertakes in taking a loan.

And while on average it looks like the risk profile of the FHA's lending has improved, about 40% of the borrowers in fiscal 2012 had a FICO score below 660 or a debt ratio above 50%. "Either of those would have been called subprime back in 2000," Pinto notes.

He believes that the agency should focus on working-class families, but do more to "de-layer risk." "If you take a 580 FICO score loan, with a 50% debt-to-income ratio, with a 3.5% downpayment and a 30-year term, that is four layers of risk."

The FHA needs to achieve a more equitable balance in its underwriting and define its tolerance for failure if it needs to stay on mission, he said.

-- Written by Shanthi Bharatwaj in New York

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