WASHINGTON -- Confidence in the overall financial system has failed and a major overhaul of regulations is needed, Treasury Sec. Tim Geithner told a House panel Thurday.

Calling the U.S. financial system the most stable in the world, Geithner said dangerous levels of risk were taken for short-term gain. 

"Over the past 18 months, we have faced the most severe global financial crisis in generations," Geithner said in testimony to the House Financial Services Committee. "To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game."

The Obama administration is proposing an extensive overhaul of financial regulations in an effort to prevent a repeat of the banking crisis last fall that toppled once-mighty institutions and wiped out trillions of dollars in investor wealth.

Congress would have to pass new rules to regulate the market for credit default swaps and other types of derivatives and require hedge funds to register with the Securities and Exchange Commission.

"Financial products and institutions should be regulated for the economic function they provide and the risks they present, not the legal form they take. We can't allow institutions to cherry pick among competing regulators, and shift risk to where it faces the lowest standards and constraints," Geithner said.

"Let me be clear," Geithner added. "The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers must end."

The program the administration was presenting to Congress includes a recommendation for creation of a systemic risk regulator, possibly at the Federal Reserve, to monitor risks to the entire system.

"The overall orientation...is to focus on the why and the what and the rationale as opposed to the who," a senior administration official told FOX News. "One of those principles will be independence so that will certainly eliminate the Treasury Department. But we will not be making a commitment to a specific systemic regulator. The focus will be on the why and the what."

"Systemic risk regulator" is the administration's phrase to describe a new regulatory body that would operate like the Federal Deposit Insurance Corporation in regulating and, when necessary, intervening to divest a bank that fails to meet safe operating standards.

The senior official said this new government regulator will "be able to look through any structure, any complexity to the actual substance of what any major financial organization is doing that could impose a systemic risk on our country."

"It is what you do and the risk you could impose, not the structure or the complexity of your organization or your efforts to compete or choose a different regulator," the official said. "After what the country has seen with AIG (American International Group) I think a far larger amount of Americans understand the danger of allowing enormous amount of credit default swaps and derivatives to be placed without oversight or regulation."

Credit default swaps were insurance policies AIG sold on packaged mortgages. The policies made these new financial products -- mortgages packaged and sold on an unregulated market -- a safer bet for investors because the insurance protected them against sizable loss. 

The plan also includes a measure that Geithner and Federal Reserve Chairman Ben Bernanke discussed before the committee on Tuesday to give the administration expanded powers to take over major nonbank financial institutions such as insurance companies and hedge funds that were teetering on the brink of collapse.

The administration, pushing Congress to act quickly on its reform agenda, sent Congress a 61-page bill dealing with the expanded powers to seize control of nonbank institutions late Wednesday and the Financial Services Committee, chaired by Rep. Barney Frank, has indicated it could move on the measure as early as next week.

Frank said the overhaul should ensure the government has more options and can avoid repeating the unattractive choices it faced last fall of letting Lehman Brothers fail, which sent a shock wave to the entire financial system, and propping up AIG with billions of dollars.

"We are looking for an alternative method to avoid those polar extremes," he said.

"We have just had a financial earthquake in our financial markets, and now we must do some major rebuilding," added Sen. Charles Schumer, D-N.Y. "Secretary Geithner's proposal brings oversight to corners of the market that previously had none, but it also keeps an eye on maintaining entrepreneurial vigor. It is a good first outline."

Many thorny details remain to be worked out. Administration officials promised that the remaining issues would be hammered out in consultation with Congress with the goal of getting legislation approved as quickly as possible.

The administration is proposing that hedge funds and other private pools of capital, including private equity funds and venture capital funds, be required to register with the SEC if their assets exceeded a certain size. The threshold amount has yet to be determined, officials said.

The proposal on credit default swaps and other derivatives would require the markets on which they are traded to be regulated for the first time and for the buying and selling of these instruments to be conducted in a way that will foster greater oversight.

Credit default swaps, which trade in a $60 trillion global market without government oversight, are contracts to insure against the default of financial instruments like bonds and corporate debt. They played a prominent role in the credit crisis that brought the downfall of investment banking giant Lehman Brothers Holdings Inc. last fall and pushed insurance giant American International Group Inc. to the brink of collapse, forcing the government to provide more than $180 billion in support.

Hedge funds, vast pools of capital holding an estimated $1.5 trillion in assets, operate mostly outside of government supervision. As the market crisis deepened last fall, hedge fund selling was widely cited as one of the reasons for increased volatility that pounded stocks and bonds.

Hedge funds also suffered huge losses last year, notably from investments in securities tied to subprime mortgages.

The outline of the regulatory reform was being unveiled a week before President Obama was scheduled to meet for discussions among the Group of 20 major industrialized and developing countries in London to assess what needs to be done to deal with the global financial crisis.

The administration is pushing other nations to follow the U.S. lead in putting together sizable economic stimulus programs to jump-start global growth. However, many in Europe are resisting those calls and arguing that the United States needs to do more to toughen financial regulations because they believe the current troubles can be traced to lax regulation in the United States in such key areas as hedge funds and credit default swaps.

The Bush administration resisted calls for tighter regulations in these areas but the Obama administration has signaled its willingness to do more and is hoping that the flaws in current regulations that were exposed by the financial crisis will spur Congress to act.

FOX News' Major Garrett and the Associated Press contributed to this report.