Your cheatin’ Alma Mater

It was reported this week that Bucknell University has been providing inflated information on the SAT scores of its incoming students for several years.  The news follow similar revelations in recent months about a number of universities, including George Washington University, Emory University, and Tulane University Business School.

The news puts these elite universities in the company of financial giants Barclays Bank, the Royal Bank of Scotland, and UBS, which have also been busted for cheating of a different sort.

Barclays, RBS, and UBS have all been implicated in the Libor scandal.  Recall that Libor, a widely used benchmark interest rate, is determined by averaging the self-reported borrowing costs of several large financial institutions.  Reporting artificially high interest rates earned the cheaters increased profits on loans tied to Libor; reporting artificially low rates made them seem as if they were awash with funds when financial markets froze up the appearance of security suited them.

Given the huge amounts of money involved—about $800 trillion in financial transactions are tied to Libor—the incentive to cheat is pretty obvious.  But universities?  Surely, these non-profit bastions of enlightenment wouldn’t stoop so low.  After all, where is the profit?

It turns out that by inflating the average test scores and class ranks of their incoming students, university administrators hoped to boost their standing in the all important US News and World Report annual scorecard of US colleges and universities.

Universities have been gaming the USN&WR ranking for some time.  For example, schools are given higher marks for having more courses with fewer than 20 students.  Many universities—my own included–offer a number of courses with enrollment caps of 19 or less, which I suspect they do for purposes of bolstering their rankings.

This sort of gaming is widespread, well-known, within the rules, and harmless.  But falsifying scores to achieve a higher ranking is fraud.  And universities, banks, and professional athletes will continue to commit fraud, as long as we live in an “it’s OK because everybody is doing it” society.  No wonder Americans have less faith in their institutions than they did 10 years ago.

There are no easy answers to these cheating problems.  The most effective response is to increase transparency and enforcement, and to change the incentives for the cheaters.

To address university cheating, USN&WR ought to make clear what data are provided by the universities themselves and which are gathered from independent sources.  They could also create a second set of rankings, based on the independently reported data only, to provide skeptical consumers with a completely unbiased measure.  Because student data is typically private, there is no simple way of mandating truthfulness when it comes to reporting test scores or class ranks.

To attack cheating among financial firms, a much greater public policy concern, the authorities must take decisive action, first and foremost by changing rules and regulations that rely on bank self-reporting.

Libor should be based on publically available market-determined rates, rather than on unverified data reported by banks.  Current rules which give banks a large say over how much of a capital reserve they need to hold, should be modified.

Bank examination should be made even more rigorous.  The stress tests recently instituted for large US financial institutions are a good start in that direction.

Finally, banks—and managers—must have more “skin in the game.”  A bank official who leaves his bank in a mess—and society with substantial clean-up costs—should not be able to ride off into the sunset with his bonus intact.

Cheaters frequently do prosper.  But we can and should make it harder for them to do so.

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