Many institutions could see their surpluses wiped out by 2012 and face financial ruin, the accountancy firm Grant Thornton reports in its analysis of the health of the sector for Times Higher Education. When universities have already been modelling a worst-case scenario of 20 per cent budget cuts, such a diagnosis is like preparing yourself for swine flu and learning that you've got cancer.

Some vice-chancellors have privately been fearing the worst despite the Higher Education Funding Council for England putting on a brave face and saying that the cuts will be nowhere near as bad. But even Hefce has had to admit that it is "prudent" to prepare for all eventualities and has revealed that seven institutions are at high risk of failure. Sources there say this number could rise to as many as 30 next year, which some in the sector believe to be an underestimation.

The spectre of universities going bust has suddenly become very real, and rationalisation looks inevitable, especially in London. The pay settlement last year and the pensions bill have put even the most successful institutions under huge strain. Before the downturn, the pay claim of 8 per cent submitted by the University and College Union seemed optimistic on top of last year's very generous settlement. In the midst of a recession and amid a wave of redundancies, it looks ludicrous. The Universities and Colleges Employers Association has put 0.5 per cent on the table. No one has the appetite for a dispute; the UCU should be gracious and accept the offer.

Many universities have attempted to dig themselves out of this financial hole, but it seems they are damned if they do and damned if they don't. On the one hand, in the face of record demand this summer, the Government has given them 10,000 extra places - but for science, technology, engineering and mathematics, the most expensive subjects to run - and then has not funded them fully. That's on top of fining them if they over-recruit home students. As there is no such penalty on more lucrative overseas students, some institutions, it is reported, are choosing to give them preference over domestic students, thus giving their coffers a much-needed boost while also inadvertently fuelling xenophobia.

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However, even this source of income looks shaky in future, Grant Thornton warns. Competition from other nations, including students' home countries, combined with fears of mounting debts and demographic change leave universities looking very vulnerable.

But if outside pressures that hamper the recruitment of foreign students aren't enough, the Government has tied the sector up in knots with its ridiculous visa regulations and a hysterical overreaction to swine flu that has turned the country into a lepers' colony in the eyes of the world.

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Unfortunately, it seems, our institutions make very poor patients: too complex and too slow to be able to respond quickly to a turn for the worse - "cumbersome operations", as the accountancy firm describes them.

For recovery, it prescribes the unthinkable: a model that puts business interests first, ahead of the core activities of research and teaching, and shunting the academics aside. It's a large dose of realism and may need more than a spoonful of sugar to help it go down.

ann.mroz@tsleducation.com.