Should States Be Chided for How They Use Their Mortgage Settlement Money?

Some states are taking heat for using their settlement funds to plug budget holes. But should they be?

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Chart detailing the National Mortgage Settlement

There's been quite a bit of chatter recently about how states are allocating their share of the National Mortgage Settlement, which required five of the nation's biggest banks to shell out $25 billion over allegations of improper foreclosure practices.

According to some reports, many cash-strapped states are "diverting" their share of the settlement—about $2.5 billion—to plug budget holes instead of investing in homeowner relief and programs aimed at preventing future foreclosure abuse.

According to settlement documents, funds paid to the states are for "purposes intended to avoid preventable foreclosures, to ameliorate the effects of the foreclosure crisis, [and] to enhance law enforcement efforts to prevent and prosecute financial fraud."

But what constitutes "effects of the foreclosure crisis?" That's the rub, according to some experts, who say states aren't in the wrong when allocating their piece of the mortgage settlement pie to non-housing related programs or even to shore up battered balance sheets.

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"The context is really important, and that's the overall settlement," says Iowa Attorney General Tom Miller who played a big role in brokering the National Mortgage Settlement. "Some people are taking a part of the settlement—about 6 percent, the $2.5 billion—and pretending like the other part isn't there."

The "other part" consists of about $20 billion in direct aid to homeowners, which includes mortgage principal reductions and payments to homeowners who lost their homes to foreclosure. According to Miller, the $2.5 billion or so the states have to play with is small fries compared with the almost $35 billion in net benefits homeowners will see as a result of the National Mortgage Settlement.

"It's not like they're taking a huge percentage of the overall settlement," Miller says. "You have to consider the whole context, not just [one] little piece."

Many states have taken huge tax revenue hits as a result of the foreclosure crisis, which have worsened already deep fissures in their balance sheets. Allocating some of the settlement funds to patch up ragged budgets could be seen as addressing damages from the foreclosure crisis, Miller says.

"If a state did take the position that the state has been harmed by the foreclosure crisis in terms of tax money and in terms of what it spent, if the state took part [of the funds] I think they have a plausible argument to do that," Miller adds.

[Read: National Mortgage Settlement Monitor Joseph Smith Weighs in on Progress in Exclusive Interview.]

States such as Georgia, Missouri, and Indiana have taken that tack, allocating all or part of their settlement funds to programs outside the specific realm of housing and foreclosure relief. In fact, nearly 40 percent of the states' settlement funds—about $967 million, according to the latest data from ProPublica—have been allocated to general funds and other non-housing related programs.

Georgia—one of the states hardest hit by the foreclosure crisis—plans to use its $99 million portion of the settlement to attract new businesses to the state in order to create more jobs, according to a recent report by Enterprise Community Partners. Missouri is using its piece of the pie to soften planned cuts to higher education. Virginia funneled almost all of its payout to the state's general fund. (To see how your state is spending its settlement share, click here.)

In all, only 27 states have devoted all their settlement funds to housing-related programs, according to Enterprise Community Partners, a figure that makes some housing hawks squirm.

"We feel [the funds] are a result of a settlement to address some of the abuses in the largest housing crisis since the Great Depression," says Amanda Sheldon Roberts, author of a recent report from Enterprise Community Partners that tracked down where states were putting their settlement dollars. "We feel strongly that these particular dollars should be used for housing."

[Read: Mortgage Settlement: Do the Big Banks Owe You Money?]

Though Miller is willing to give states a little leeway when it comes to spending their settlement funds, he, too thinks the majority of the funds should be focused on homeowners.

"States should spend a significant part of [the funds] to help deal with and fund the infrastructure to help homeowners in crisis," he says. "Beyond that there's a number of options."

Not all of the settlement funds have been allocated by states—about $1 billion still hangs in the balance—so those who feel the settlement funds should only be earmarked for housing might still get their wish.

Meg Handley is a business reporter for U.S. News & World Report. You can reach her at and follow her on Twitter.