Paulson hedge fund now looks to buy banks

The man who made a personal $3.7bn (£1.85bn) fortune by predicting the credit crisis is hoping to make another killing by helping to prop up financial companies brought to the brink of ruin by the chaos in the debt markets.

John Paulson, who went from being an obscure Manhattan hedge fund manager to one of the financial world's hottest properties last year, is raising a new fund that will invest in banks, insurance companies and other financial institutions as they rebuild their battered balance sheets.

Financial companies have written off more than $460bn since the collapse in the debt markets began last summer, and Mr Paulson believes that is barely one-third of the final total that will be lost. At a conference in Monaco last month, he said writedowns could ultimately reach $1.3 trillion.

When those losses are finally worked through the system, he believes, financial companies will be desperate for new capital, and a fund that is flush with cash will be able to make investments on very favourable terms.

Planning is understood to be at an early stage, prospectuses for the new fund have not yet been produced, and it is unclear at present whether it would invest in equity or debt. Mr Paulson is expected to launch the new fund close to the end of this year or early in 2009. The company refused to comment.

Mr Paulson set up his hedge fund company in 1994 and spent more than a decade as a middle-ranking fish in an increasingly crowded pond until, 18 months ago, he settled upon what Alpha magazine, the industry bible that calculated his winnings, called "the greatest hedge fund trade of all time".

His central realisation was that the mortgage market was headed for disaster, because millions of US homebuyers were signing up to loans they would not be able to afford. There would soon be a day of reckoning for borrowers and their profligate lenders, he calculated, and the multibillion- dollar market for mortgage derivatives was bound to collapse.

His company went from managing $6bn of assets at the start of 2007 to $33bn now, largely thanks to its Credit Opportunities Fund, which rose six-fold in value last year.

With its new-found influence, Paulson & Co has been able to sign up Alan Greenspan, a former head of the Federal Reserve, as an adviser and he is likely to be helpful to the new fund in assessing the capital needs of the banking sector for which he was once the chief regulator. The appointment raised a chuckle in dealing rooms across Wall Street when it was announced in January, since Mr Greenspan is being damned as the architect of the housing market's disastrous bubble.

Financial companies have raised $345bn in new capital since the credit crisis began a year ago, according to Bloomberg data, much of it from overseas governments' so-called "sovereign wealth funds". More recently, financial firms have sold assets and slimmed down their trading portfolios to conserve cash.

Hank Paulson, the US Treasury secretary who is no relation of the hedge fund manager, has repeatedly told firms to raise new capital. Without it, they are going to be constrained in offering credit, which is the lifeblood of US economic activity.