The Texas General Land Office on Monday sent a letter to Galveston reminding Mayor Lewis Rosen of the possible loss of millions of dollars in recovery funds.
Ike pounded Galveston on Sept. 13, 2008. The dispute involves 569 public housing units that flooded and had to be demolished.
Rosen has proposed offering rental vouchers instead of rebuilding.
U.S. Housing and Urban Development officials have said Galveston must stick with a rebuilding agreement reached two years ago. HUD on Friday reiterated its stance.
The head of the Galveston Housing Authority, Irwin "Buddy" Herz, says the dispute should be submitted to a federal judge.