Background. The state of California will receive about $411 million in 2011-12 as part of a nationwide settlement against five major banks for alleged unlawful foreclosure practices. According to the California Department of Justice (DOJ), which represented the state in the settlement, qualifying borrowers and communities in California will also receive up to $17.6 billion in direct benefits from the defendants.
As part of the settlement agreement, DOJ agreed to designate 10 percent (or $41 million) as a civil penalty for the state’s general use, while stipulating that the remaining 90 percent (or $370 million) would be set aside for specified purposes related to housing, such as fraud investigations, consumer education, and aid to homeowners.
Governor’s Proposal. As part of his May Revision, the Governor proposes to use the entire $411 million to benefit the General Fund in 2011-12 ($171 million), 2012-13 ($121 million), and 2013-14 ($118 million). In addition to using the $41 million penalty to offset various DOJ General Fund costs, the Governor proposes to offset General Fund costs in the following areas: (1) a portion of the annual debt-service costs for housing bonds authorized by Propositions 1C and 46 ($287 million), (2) the Division of Law Enforcement and the Public Rights Legal Division within DOJ ($70 million), and (3) Department of Fair Employment and Housing programs combating housing discrimination ($12 million). The administration states that these are the state General Fund costs that could best be considered homeowner-related programs eligible for offset under the settlement agreement.
LAO Findings. We believe the administration’s proposal to use the settlement proceeds to provide budgetary savings makes sense given the state’s fiscal situation. However, some of the expenditures that the administration proposes to offset with the settlement proceeds may fall outside the intent of the settlement agreement to the extent that they do not directly relate to consumer fraud, borrower relief, services for homeowners, or other specified uses. For example, the administration proposes to fully supplant General Fund support for DOJ’s Division of Law Enforcement, which conducts investigations into organized crime, gangs, and drug trafficking. This may expose the state to legal challenges.
However, while the administration takes a cautious approach by limiting the expenditure of settlement funds to homeowner programs as prescribed by the agreement, we believe the Legislature is not legally restricted from appropriating these funds for other purposes. The settlement provides damages that were awarded directly to the state and that are not being held in trust for particular individuals. Therefore, the terms of the settlement agreement do not limit the Legislature’s appropriation authority. Consequently, we believe the full amount of the state’s settlement is available for appropriation in the current and budget years to cover costs not contemplated by the settlement agreement.
LAO Recommendation. We recommend modifying the Governor’s proposal to use the full $411 million settlement to offset General Fund costs in the current and budget years, rather than reserving $118 million to offset costs in 2013-14. Specifically, we recommend (1) increasing to $212.5 million the proposed 2012-13 General Fund offset to debt-service costs for Propositions 1C and 46 bonds, and (2) decreasing to $4 million the proposed 2012-13 General Fund offset to the Division of Law Enforcement to reflect committee action that reduced the division’s General Fund appropriation by $2 million. We believe the magnitude of the additional budget year savings justifies any legal risk associated with offsetting General Fund costs less directly related to the settlement.