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Freddie Mac Looks To Move On From Accounting Fiasco

The world doesn't stand still while a company gets its house in order. While Freddie Mac was putting out fires, it was missing opportunities. Now it's bringing IT work in-house and replacing custom and proprietary code with off-the-shelf software.

Talk about the tyranny of the urgent. In 2003, Freddie Mac disclosed massive problems related to its derivatives accounting that would lead to about $5 billion in earnings restatements and get its executives called before congressional committees to explain the mistakes at the federally regulated mortgage-financing company. It's the kind of problem that consumed every department at the company, including Freddie Mac's IT team.

Freddie Mac's changes aren't quite in the DNA--yet--Smialowski says

Freddie Mac's changes aren't quite in the DNA--yet--Smialowski says

Photo by David Deal
But the world doesn't stand still while a company gets its house in order. While Freddie Mac was putting out fires, it was missing opportunities. The secondary mortgage market where Freddie buys home loans from banks and resells them as mortgage-backed securities--it holds about $1.5 trillion in loans--was undergoing major change. Remember the rampant mortgage refinancing in 2003 and 2004 and the increasingly exotic loan options being offered? People loved the new choices: Interest-only and adjustable-rate mortgages accounted for about two-thirds of loans made in the second half of 2004, according to the Mortgage Bankers Association.

Freddie Mac was trying to keep pace using IT systems custom coded in an era when mortgage choice meant picking between a 15- or 30-year loan. "The market moved on us," says Joe Smialowski, executive VP of operations and technology. Plus, the company faced new competitors, with commercial and investment banks playing a bigger role in the secondary markets, alongside traditional rivals like Fannie Mae and the Federal Home Loan Banks.

To keep up, Freddie Mac has set a broad business goal to "touch more loans"--that is, evaluate more loans and more types of loans. As part of that effort, the company isn't just tinkering with IT strategy; it's turning it upside down:

• Out with a preference for custom coding and proprietary code; in with off-the-shelf software and mortgage-industry standard technology wherever possible.

• Out with myriad contractors, who used to handle 60% of project work; in with, well, in-house staff, which it's been hiring by the dozen. Freddie's goal is for 70% of IT work to be done by staffers.

• Out to new labor markets, as Freddie opens its first satellite IT office to lessen its dependence on the tight job market around its northern Virginia headquarters.

One example of the many changes is what Freddie Mac has done with its legacy business-decision software, called Loan Prospector. The system is blazingly fast at what it was written to do: In 15 to 20 seconds, it can automatically assess if a loan is right for the company to buy. But it's inflexible because the business rules for judging a loan are hard-coded using Cobol and proprietary data tables. Changing that code to evaluate a new type of loan takes months of programming. A project under way will cut that to weeks, and possibly days, by stripping the business logic out of the legacy code and adding off-the-shelf rules engine software.

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Another example is Freddie's decision this month to outsource the back-office transaction processing for a $700 billion asset portfolio to JPMorgan Chase's services group. Freddie expects that connecting JPMorgan's transaction services to its trading and accounting systems will improve and speed up its accounting processes and enhance business continuity.

Freddie plans to spend $350 million this year on new IT-driven functionality, most of it powered by commercial software or services under a new buy-and-integrate strategy. It's all part of a high-pressure, high-speed effort to get beyond the accounting and regulatory compliance demands that dominated the company's attention during the past several years.

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