Hedge fund managers are paranoid. And they are right to be. The other day I had lunch with a senior financial official whose view of hedge funds was simple. “They were a con. The returns were all due to leverage. And now that the leverage has gone everyone will see they were a con.”

You may disagree with this analysis. You may be convinced that for some hedge funds at least the returns were down to skill. You may argue that their role in the credit crisis has been at worst neutral. But you cannot deny it is pretty worrying for hedge funds when this is the view of a top regulator.

And my lunch companion is not alone. According to an e-mail from Dick Fuld, the former chairman of Lehman Brothers, quoted by The Wall Street Journal, Hank Paulson, the US Treasury Secretary, said he wanted to “kill” the bad hedge funds and “heavily regulate the rest”. The Italian Finance Minister has promised to put the extermination of hedge funds on the international agenda when Italy takes over presidency of the G8 in January.

The bankers are all blaming the hedge funds. Even John Mack, chief executive of Morgan Stanley, which has made a fortune out of hedge funds, blamed hedge funds shorting the stock for bringing the bank to the brink a couple of weeks ago.

The regulatory backlash has already started with the ban on short-selling of financial stocks. It is not clear what difference this has made to bank stocks. They have continued to decline, though with much wilder swings.

Perhaps short-sellers did cause the sharp fall in bank share prices that forced the Government to mount its bailout plan. But is that a bad thing? Perhaps they should be congratulated for forcing the authorities to act now, rather than later. It was hedge funds that first questioned Northern Rock's reckless dependence on wholesale funding five years ago and started shorting the shares. If the Financial Services Authority had also questioned bank business models at that time, the taxpayer might not be looking at such a monstrous bill to clear up the resulting mess.

Of course, the question of whether regulators are justified in cracking down may be rather academic. Mr Paulson may not need to kill the bad hedge funds. The market may do it for him.

Hedge funds are having a very tough time. Performance has been dismal this year, with the average fund down about 10 per cent according to Hedge Fund Research. That may be a lot better than the stock market but it is hardly the absolute returns that hedge funds are supposed to deliver. (Down a bit is the new up, runs the gag.)

The ban on short-selling has not helped by undermining some important hedge fund strategies. Nor have the problems of the investment banks, which have forced them to cut back on lending to hedge funds. Access to leverage will never return in the same way, which has serious implications for funds that relied on borrowings to spice up their returns. The wild market gyrations of recent weeks are likely to have caught out some funds. And investors are now spooked with funds suffering a flood of redemptions.

But the good funds should survive, indeed may thrive, given the reduced competition. The regulatory backlash may merely drive them offshore. The industry will be smaller but its predicted demise looks as exaggerated now as it was after the collapse of LTCM ten years ago. A senior German politician memorably described private equity funds as locusts. Hedge funds are more like cockroaches. They get a bad press but are very hard to kill.

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