Short-seller with a £1bn bet that British banks will fall

A hedge fund named as a major short seller in a string of British banks was defiant today, saying: "These companies are not strong."

Paulson & Co, run by US billionaire John Paulson, was identified by the Financial Services Authority as gambling that four British banks would see their share prices plunge.

Its identity was revealed after a temporary ban on short selling in 32 financial firms, the practice in which investors borrow shares, sell them and gamble that they will be able to buy them back for a lower price at a profit.

Shorting was blamed for the crisis which led to the collapse in the value of HBOS, forcing it into a merger with Lloyds TSB.

Paulson & Co was revealed as shortselling four of Britain's five biggest financial companies by holding £1 billion in shares. It has short positions of £352 million (1.18 per cent) in Barclays, £260 million (1.76 per cent) in Lloyds TSB, £90 million (0.95 per cent) in HBOS and £292 million (0.87 per cent) in Royal Bank of Scotland.

Today a senior Paulson & Co source told the Standard: "We are not doing anything wrong. We believe these banks have excessive leverage and are definitely under-capitalised. They still have exposure to mortgage and real-estate investments which are deteriorating on a daily basis.

"There is nothing which proves that hedge funds shorting particular stocks causes companies to fail. We realise that the media will talk about hedge fund managers' behaviour as the root of all evil. But there's one reason why a bank's stock will fail and that's because of the way they manage their own business."

The shorting ban was put in place as Hector Sants, the FSA chief executive, said regulators needed to act to "protect the financial integrity and quality of markets". Chancellor Alistair Darling said that although "short selling is not the prime cause of the present financial turmoil it has made it far worse in recent weeks by undermining financial companies".

Asked about Mr Darling's comments, the hedge fund source said: "He is right that short selling is not the prime cause of the financial trouble but there is nothing to back up his other claims. "Being a politician, he has to be seen to be doing something. We realise politicians and regulators have to do something, you can't just do nothing."

Mr Paulson, a New Yorker who studied at Harvard University, has made a fortune on the strength of forecasting doom for the sub-prime mortgage market. Last year he earned £2 billion - believed to be the highest annual payday in Wall Street history with two funds set up by his firm increasing in value by £8.1 billion, up 600 per cent year-on-year.

He was refusing to comment yesterday, instead issuing a statement that said: "Our short positions are taken on a passive basis, the success of which will be determined by the merits of the particular company."

Mr Paulson comes from the New York borough of Queens but now lives in a five-storey townhouse in Manhattan's Upper East Side with his wife and two daughters. He also owns a £22 million lakefront estate in the Hamptons.

He once said his favourite quote was Winston Churchill's "Never give up, never give up, never give up."