An independent audit of the Federal Housing Administration (FHA), which insures more than $1 trillion in U.S. mortgages, shows the agency is in massive financial trouble. The FHA is legally required to keep capital reserves equal to 2 percent of the total book value of its single-family mortgage insurance program. But the audit, released in November, found that reserves were lower than required, and that the FHA was already $16.3 billion in the red.

Bad loans made prior to 2010 were the biggest reason for the trouble. In particular, the report focused on loans made between 2007 and 2009, as the economy flailed and the housing market tanked. The volume of bad loans on the books is impressive: More than a quarter of the loans made in 2007 and 2008 were seriously delinquent as of last summer, as were 12 percent of 2009 loans. Over all, Edward Pinto of the American Enterprise Institute estimates, more than 17 percent of FHA loans were delinquent by the end of September.

The FHA has struggled to meet its reserve requirements for years. In 2009 its capital reserves were hovering near zero, well below the statutory requirement, at just 0.53 percent. Since then, the total value of the FHA’s mortgages has increased from $685 billion to $1.1 trillion, and reserves have dropped to –1.44 percent.

FHA officials insist the agency will not need a bailout. But if anything, the new report understates the magnitude of the problem. As long as mortgage interest rates remain low, borrowers with good credit are likely to refinance their way out of the government’s portfolio, leaving the FHA holding an even larger percentage of loans that are unlikely to be repaid.