Escrow Accounts: Change to Solve Legal Aid Crisis?

A New York Times story published this weekend mentions a new problem from the current credit crisis: funds for legal aid.  It turns out that many state bar associations have found resources for legal aid from escrow accounts.  The programs are known as Iolta (Interest on Lawyers Trust Accounts) and they generated $212 million for legal aid across the US in 2007.

If you have ever purchased a home and negotiated for the seller to throw in some dollars to help fix up, say a roof, then you have put funds in escrow.  Those dollars generate interest.  The interest doesn’t go to you, though…and in many cases, it ends up paying for lawyers to represent indigent defendants.

As our federal government is lowering the cost of lending, the interest on these accounts is bearing a very low return.  This is unfortunate timing, as right now there is a surge in need for defense.  The foreclosure crisis in North Carolina has brought a lot of work to NC Legal Aid.  I imagine other states are the same, and that places like California, Florida, and Nevada are all the worse.

Individual escrow accounts are routed electronically by participating banks into a common NC IOLTA account.  Banks provide the transfer for free.  Some banks pay higher than normal interest for these accounts (BAC, BBT, WB, RY, see full list).

This seems like an inspired idea that is helping people.  Yet, the interest rate risk is apparent and would likely happen whenever the government wanted to stimulate the economy.  I wonder if the policy for handling escrow accounts could be changed.  In many states, there is  a less-than-normal appetite for municipal bonds.  Right now, a county with a AAA rating is still paying at least four percent for bond issues.  That would exceed what most checking accounts are paying by a large margin, and it would still bear very little risk.

The best fit, in fact, would be to park those escrow dollars in municipal bonds dedicated to state housing finance agencies.  The interest payments could still go to legal aid.  In fact, it might generate a lot more income.  (Wachovia savings accounts are paying less than 0.05 percent interest right now.)

But then there is the positive result that could come from putting that money into municipal bonds.  Consider how this might work in one state – North Carolina.   In North Carolina, advocates have sought a $50 million appropriation for affordable housing development for some time.  That would be a big increase.  As recently as 2007, North Carolina’s affordable housing bonds paid for $18.1 million in housing.   Switching escrow accounts from savings to municipal state housing finance agency bonds would instantly create some of the demand to meet that goal.