I'm Doug, and I'm very sorry to hear of your situation. My goal is to provide you with excellent service today.
You are correct, as to the reason that your wife's spouse benefit has been discontinued---it is because of the lump sum payment from the teacher's fund.
Your wife's lump sum payment is treated as a government pension for WEP purposes. The union's pension plan will usually prorate the lump sum to determine a monthly amount for WEP purposes. If they did not do this, then social security has a method for determining the amount.
The termination of your wife's benefits by social security is incorrect and you will want to appeal the decision and argue that only the very minimal lump sum will be received and that social security needs to apportion that small payment over the years that your wife will be entitled to her spouse benefit. There should only be a very small decrease in her benefit based on the tiny amount of lump sum benefit she is getting.
Your wife should go to the local social security office and refer them to this following regulation that seals with lump sum calculations: https://secure.ssa.gov/apps10/poms.nsf/lnx/0300605364
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I wish you and yours the best this holiday season,