The government is considering cutting student grants and freezing the number of university places after it drastically miscalculated increases in the bill for higher education, the Guardian has learned.
It would constitute a major U-turn, reversing last year's pledge to raise the number of students eligible for free money while they study and a key policy to boost the number of graduates.
The move, which would apply to England alone, would be fiercely opposed by students and universities, and risks a serious political backlash.
Sources said the problem stems from the rushed creation of the Department for Innovation, Universities and Skills and the sudden announcement of a massive expansion of student grants, within eight days of Gordon Brown becoming prime minister in July 2007. A senior Whitehall source said the plan, which means two-thirds of students are eligible for some kind of grant at the cost of hundreds of millions of pounds each year, was not properly costed, leaving a hole.
The source called the announcement to expand grants "a fingers in the sky" exercise which meant the new ministry was not allocated enough money to pay the grants from the start. Ministers were also caught out by a boom in applications.
The department is understood to be short of more than £100m. Its overall annual budget is £17bn.
Universities also face a freeze on student numbers, effectively suspending the government policy to expand the university system and boost the number of graduates. The government is committed to a long-term plan to improve the nation's skills and fuel the recovery from the economic downturn, but there may have to be a short-term freeze to claw back some of the spending.
The Guardian understands ministers are in intense discussions about the details of how to meet the rising bill of higher education and about how to limit the impact of any decision on students. Moves are being made to divert money from other spending inside the ministry, but senior government sources suggested these would not be enough to plug the gap.
If the secretary of state responsible, John Denham, can't find the cash from within the department he faces the option of reducing the amount students receive, the proportion who qualify, or cutting funding to universities for students already on their books. He is expected to make a statement to parliament explaining the emergency changes.
A source close to the discussions said: "Universities have been successful and recruited more students. But the cost is higher, so they've got to save and one obvious way is to change the system. They don't want to cut grants or numbers but they've got to find the money."
The expansion of grants was introduced last month. It meant students from families with incomes of up to £25,000 are entitled to the maximum grant - a big rise from the previous threshold of £17,500. Students from families with incomes of up to £60,000 were also entitled to a new partial grant. They estimated that a third of students from this September would receive a full grant worth £2,825 a year and a further third would receive a partial grant on a sliding scale.
The number of students starting university this year in England rose by 10.5%, taking ministers and universities by surprise. The biggest rises were among students from poorer socio-economic backgrounds, putting intense pressure on the funding pot.
One university head said it made universities victims of their own success in expanding numbers. "Universities are bracing themselves for unpleasant news," he said.
The expansion of grants was widely welcomed when the July 2007 announcement was made, but its scale stunned some within the university sector.
Bahram Bekhradnia, director of the Higher Education Policy Institute thinktank, said: "Increasing grant support immediately made it a much more expensive package and it seemed completely unnecessary at the time - the overriding political interest was widening participation but this did nothing for that as these people were going to university anyway.
"It was very strange and was clearly political. It didn't seem to fit with an economic or policy need and added to the cost of what was already a very generous and costly arrangement."
Wes Streeting, the National Union of Students president, said: "If this is confirmed it would be outrageous. In a serious economic downturn it's shocking that one of the first groups to be picked on could be the poorest students in higher education. In terms of social justice this would be a complete setback."
A department spokesman said: "The government is fully committed to the expansion of higher education and can ensure finance should not be a barrier to those that want to do a degree."
