We are, as the Moody Blues sang, living in strange times. Two years ago the economy was buoyant and among the electorate Gordon Brown was widely considered one of the most competent chancellors the UK had ever seen. Now the picture could scarcely be more different.

But what does the downturn mean for the higher education sector? At this stage, it is still hard to say. Information about the true depth of the problem has emerged only relatively recently. As the sector moves in yearly cycles, rather than the monthly or quarterly cycles common in the business world, the knock-on effect will take longer to hit universities.

Nevertheless, early problems are visible and the exposure of some UK universities to the collapse of the Icelandic banking system focused minds. But the credit crunch is likely to have an impact on every area of a university's work: financial management, building projects, admissions, pensions and collaboration with business and industry.

As Karel Thomas, executive officer of the British Universities Finance Directors Group (BUFDG), points out: "The reduced availability of credit hasn't left the university unscathed at all."

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Even so, university finance directors are fighting back. "There is a lot of imaginative thinking going on. You suddenly find that people are talking to each other a lot more than they did when times were good. It's a bit of wartime spirit," she says.

Admissions

And universities might benefit from the crunch in some ways. For example, many people who are made redundant re-enter education to improve their long-term employability.

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"Using time positively in an MBA programme is a good thing to do while the economy isn't providing good job opportunities," says Glenn Sykes, managing director of the Europe campus for the University of Chicago Graduate Business School.

According to Rick Trainor, principal of King's College London and president of Universities UK, this pattern of higher admissions is being repeated across the UK.

"It's clear from the latest Universities and Colleges Admissions Service figures that increasing numbers of people are applying to university. People continue to see higher education as a worthwhile investment in their futures," he says.

But Craig McAllister, dean of the Crummer Graduate School of Business, Rollins College, warns: "The credit crunch is a general deal-breaker. Students who come to professional schools take on professional debt; they use professional loans. What we've found is that a lot of banks are choosing not to (offer) those loans."

Moreover, previously encouraging employers may be more likely to retract offers of support, leaving students no choice but to quit courses.

International students

"We are anxious about uncertainties in the global economy and the possible impact on the numbers of international students willing to travel for their education," says Geoffrey Crossick, warden of Goldsmiths, University of London.

Nevertheless, Study Group UK, a private firm of international student recruitment co-ordinators, says it has yet to see a drop in interest. "There may be a slowing down of the growth but ... the demand we're seeing at the moment is up on the current year. I think that's an increasing trend," says managing director James Pitman.

"Developing economies do not have the higher education infrastructure to satisfy the demand of the (growing) middle class who want to have their children educated to the highest level. A UK education is still seen as a gold standard worldwide," Pitman adds.

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But fluctuating exchange rates could pose a threat to income, particularly for those universities reliant on high tuition fees.

According to a report by accountants Grant Thornton for Times Higher Education, there are 11 institutions that depend on this income and would find themselves "particularly vulnerable in a downturn". Seven universities (including City University London and the School of Oriental and African Studies) could fall into the red if their overseas income drops by a modest 10 per cent, Grant Thornton suggested.

While some universities are worried, Crossick argues that it's a opportunity: "The dramatic fall in the strength of the pound makes the UK a lot less expensive."

Government funding

"Government funding for research has greatly improved and for teaching it has stabilised after a long period of decline," Crossick says. "We're worried that these achievements might be undermined by the need to address the crisis in government finances. That is our greatest concern."

Funding for higher education and research is at a record high, but public spending is due to tighten dramatically and institutions may struggle to cope with a thinner spread of funding in light of the research assessment exercise results to be announced in March. Various sector bodies have made high-profile appeals to the Government, warning that the UK requires excellent universities to upskill the workforce and carry out the first-class research needed to ensure global competitiveness.

"Building and sustaining a world-class higher education sector must be regarded not as a cost but as an essential investment in the UK's economic welfare. With the right levels of support, the higher education sector will be a key player in stimulating a recovery and in safeguarding the UK's long-term success as a global competitor," says Wendy Piatt, director-general of the Russell Group.

Crossick agrees. "As the UK emerges from recession it will do so as a knowledge economy in which skilled and educated graduates and high-quality research will be ever more important. It would be a very false economy to underinvest in universities when they are most needed," he says.

Finances and investments

"Universities always have to be one step ahead of the game. All universities will be reviewing their business plans and markets," says Pam Tatlow, chief executive of the Million+ group of universities. But despite her assurances, many institutions have been overtaken by events. When the Icelandic banking system collapsed last year, many, including the University of Exeter and Manchester Metropolitan University, took a hit as some of their cash was frozen. Both confirmed that the sums affected represent only a small percentage of their assets, but nevertheless it has caused alarm in the sector.

Manchester Met lost ?10 million as Heritable Bank, a subsidiary of the Icelandic bank Landsbanki, went into administration. "We are hopeful that the authorities will secure the unfreezing of our assets. We would like to emphasise that the freezing of these assets will not have a negative impact on (our) day-to-day functioning," the university says.

Exeter has ?2.5 million in limbo, but at least its financial disaster planning has paid off. "(Our) investment strategy is to spread (the) risk so that no single bank holds a sum large enough to seriously damage the operation of the university. This has worked exactly as it was meant to," it says.

"We aren't anticipating any reduction in our infrastructure plans. While the potential loss of ?2.5 million clearly isn't a good thing, it represents only a small part of the funding for this investment."

But the BUFDG's Thomas predicts a worse fate for other institutions as asset values plummet. "Where institutions are relying on an equity for a return as part of their income to fund their financial plan, they're going to find that dividends are down and therefore income is down. That will mean that capital projects or longer-term investments will have to be put on hold until the market recovers."

Projects are being reviewed, but "that will take time. In the meantime, building companies are laying people off. Universities are having to rework their plans and go back out to tender, and the whole thing could go back to the drawing board," Thomas says.

Institutions with lower reserves to call on may be forced to borrow and that will be harder because of the crunch. Meanwhile, universities once on the verge of securing deals with banks have found that unless the agreement was actually signed, the offer has been withdrawn. And they cannot rely on the sale of property to solve the problem.

Spending is under review. Although core areas may not be cut, academics can expect to see sabbaticals cancelled, hiring freezes instituted in their departments and travel bans imposed in an attempt to save money where possible until the value of their institutions' assets rises again.

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Pensions

"Pension funds are a real issue," says Thomas. For universities, the credit crunch has come at a time when the financial situation is already strained thanks to an expensive sector-wide staff pay settlement and the expanding black hole in the sector's pension pot.

"With pension funds, those universities that are in schemes that are funded - well, those payments need to be funded," she says. The Pension Protection Fund, whose recent figures show that the shortfall faced by the 6,468 final-salary schemes in deficit has risen from ?36.9 billion to ?122.1 billion in a year, has said that institutions with funds in deficit should strive to plug the gap within ten years.

"That's just impossible for most universities to think about. A lot of pension fund investments are in equities. If the capital value of the fund diminishes then that has an effect on the employers' balance sheets. It also makes the gap between the assets and the liabilities that much greater and puts pressure on the funds," says Thomas.

Ultimately, the credit crunch will force universities to make the tough choice between ploughing more cash into their staff pension schemes or cutting members' benefits.

Accommodation

Remarkably, in the face of the property market slump, the value of student accommodation is holding its own.

"The student accommodation market is very, very strong. As a class it's probably the best-performing asset in the whole of UK property," says Philip Hillman, partner at property consultancy King Sturge.

Rental growth in student accommodation in the provinces hit 6 per cent this year. In London, growth is double that at 12 per cent. Demand still exceeds supply and universities can have confidence in taking income from this source.

"I have been saying to universities that they are very fortunate if they have got a significant amount of student accommodation. For many years, it's been a loss-making part of their business, partly because they were not being as aggressive on rental as the private sector and were more focused on pastoral care," says Hillman.

"There has been a change in culture over the past two to three years and many universities (have) realised that in order to invest in their residential estate they need rents that enable them to have some money to put back into the estate."

Once good assets, property portfolios are now invaluable with universities facing a range of options when it comes to managing their housing stock.

Perhaps the most sensible of these is to lease accommodation out to a management and development company, which will modernise the homes, allowing the university to free up cash to spend on its academic estate.

"There is a recognition that to be competitive as a university they really do (have to) give a quality offering to their students in terms of lifestyle. There is still a considerable amount of development funding available," Hillman says.

Wise universities will now demand an income from the management company during the period of the lease, making the most of the value of their accommodation and releasing that capital. "It's becoming increasingly important for them that they do get some form of capital receipt if they're going to do a deal with a third party."

Recruitment

Recruitment within universities is typically fluid, with academics moving between institutions and around the country as they climb the career ladder. But as house prices plummet and mortgages are harder to obtain, potential applicants for vacant posts are becoming nervous about moving jobs.

Major headhunters suggest that universities will now need to pay up to attract top employees in this tough economic climate.

"For the top vice-chancellor posts or deans of (elite) business or medical schools, it is usually possible to construct a remuneration package, including relocation, that is in anyone's language pretty generous. It doesn't necessarily mean that it's any easier to get the candidate but you have got more ammunition to go into battle with," says Alex Acland, principal at executive search firm Heidrick & Struggles.

At the middle-management level, tough decisions have to be made by both applicant and employer. "The bottom line is that in the UK we are all feeling the pinch compared (with) three or four years ago, when it was easier to persuade a candidate to relocate for a new job. Considerations that a few years ago were less of an issue - house prices, stamp duty and interest rates - can now be deal-breaking concerns."

A generous relocation package can make all the difference. "Universities have got to put their money where their mouth is. If they are fighting a war for international talent, which the Russell Group and 1994 Group say they are, institutions are going to have to construct far more attractive and flexible relocation packages," Acland says.

Yet the sector's stability may make it attractive to employees. One academic at a Guild HE institution says that it has expected an increase in applications for some posts as a result.

"As we are already oversubscribed and near the top of the contract range, it is more about being able to select the best candidates. We might also expect to see an increase in applications for support roles and less turnover there as we pay well for the region and are seen as a safe employer."

Knowledge transfer and business links

Universities' income from technology transfer and business links is at risk of drying up. In short, it will become far harder for universities to secure investment to set up spin-off companies. "Things take longer in a downturn and I think we will experience that quite a bit. One of the challenges of this activity is to get people to invest in us and I think it will be harder," says Tom Hockaday, managing director of Isis Innovation, the University of Oxford's technology transfer subsidiary.

But Hockaday says there are opportunities to break into new markets using academic consulting services. Universities could also work with companies hoping to stay ahead in business and make money despite the economic climate by investing in the very latest innovations, as he intends to do. "We may be ahead of the game if Oxford finds the right companies to work with, companies that recognise that taking on board new technologies is a good thing to do," he says.

Meanwhile, the sector is preparing to help industry to pull itself out of the slump. UUK has published a document that says universities can shorten the period of decline through knowledge transfer, skills training and workforce development.

The document, Standing Together: Universities Helping Businesses through the Downturn, argues: "Our universities and higher education colleges are better placed than ever to help them cope. Through consultancy programmes that can help businesses become more efficient or profitable or through higher-level training courses that can improve the productivity of staff members, universities are already making a big difference in thousands of companies across the country."

A Council for Industry and Higher Education (CIHE) paper sent to Higher Education Minister David Lammy reinforces the message. "During the previous recession of the 1990s, the US maintained its investment in research while the UK cut back. The result was that the US was much better able to power itself out of recession than we were. We must learn the lessons from the past."

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The CIHE also cautions against over-optimism, as it predicts that universities will not be willing to develop expensive new business relationships while they are worried about allocating their own scant funds.