THis is not a "friend".... this is a person who is using you!
You are looking for a "nice" way to tell her that you can't watch her children any longer... I don't know if thats possible!! By having her children in your home, you are traumatizing/scaring your own children, you are having your property vandalized and items broken, and you are stressed out which causes you to smoke too much and lose your hair. There is only one person who is getting anything good out of this situation, and that is your "friend"...if she was any kind of friend, she would see what this is doing to you, and your children, and your property- and she would either change the situation or atleast change her own ways of dealing with her kids. But I think she is a self centered manipulative person who doesn't care how this is effecting you as long as she has free child care.
These kids deserve better. You can't change their lives, its not up to you, its up to their mother. What you need to do is tell her that you can't take care of her children any longer because its interfering with your own family too much. Don't feel bad or guilty about it, either-- you are doing the right thing for yourself and for your children. This woman's problems are being brought on by herself. Its sad, but you shouldn't have to suffer because of it.