Treasury Secretary Henry Paulson was highly critical of American International Group’s oversight, calling for federal regulation of insurance companies during an appearance on “Meet the Press” on Sept. 21.

In his comments, Paulson called AIG “very much a hedge fund on top of insurance companies.” AIG, he said, was a “classic example” of the need for “new regulations, new policies.”

Paulson earlier this year called for a radical revamping of insurance regulation, starting with the establishment of a federal Office of Insurance Information, and ending up with an optional federal charter. He said the current crisis reinforces his earlier view about inadequacies in regulatory oversight.

“We have a patchwork regulatory system that is outdated, is not a credit to our country, and doesn’t match the financial world we are dealing with today,” he said. “What has gone on here is terrible. And it is inexcusable and we need to deal with it.

“It would have been, in my judgment, unthinkable to have AIG declare bankruptcy,” he said, adding that the carrier was “a few hours away from declaring bankruptcy” when a deal was struck with Treasury and the Federal Reserve to extend an $85 billion line of credit in return for 79.9% of AIG’s equity.

“Something like this [bailout] in my judgment should never have happened,” Paulson said. “But we did this to protect the taxpayer. And this was something we are going to deal with in the future in terms of our regulatory system.”

Citing the differences between AIG and Lehman Brothers, which the government earlier in the week allowed to fail, “what the government did [with AIG] is come in, in a senior position, assume the debt well ahead of the shareholders in an $85 billion funding facility, to allow the government to liquidate the company in a way in which we are avoiding a real catastrophe in our money markets,” Paulson said.

He acknowledged that “it is going to take some time to figure out” how to revise regulation of the financial system, “and do it carefully and well.”

He then talked about the blueprint for regulatory change he unveiled on March 31, and the importance for more comprehensive regulation of all financial institutions.

The blueprint calls for legislation that would create an optional federal charter for insurers, and, in the interim, the creation of an Office of Insurance Information within Treasury, which would provide the federal government with data on state-regulated insurers, and give the federal government specific authority to negotiate insurance trade agreements with foreign nations.

Such legislation, H.R. 5840, is currently stalled on the House floor.

“We can’t deal with that in a week, and we need this legislation in a week,” he said, referring to a bill being crafted to create a federal facility to buy bad mortgage debts stemming from subprime loans and their securitization, “because we have a problem in our capital markets that’s urgent to deal with. And we can deal with it when we get the legislation from Congress.”

Under the Treasury Department plan–submitted to Congress in the form of legislation Saturday–the agency would have the authority to buy $700 billion in bad mortgage-related debt.

It was submitted in hopes of staunching a financial crisis that saw 3 of the 5 major Wall Street investment banks swallowed up or fail within 3 months.

Last week, the Federal Reserve Board approved on an emergency basis the application of Goldman Sachs and Morgan Stanley, the 2 remaining investment banks, to become bank holding companies.

Insurance companies would have the ability to sell troubled mortgage assets to the fund being sought by the Treasury Department, under the definition of “financial institutions” included in the legislation submitted to Congress.

According to a provision in the legislation, “financial institution” is defined for purposes of being able to sell troubled assets to the government to mean “any institution including, but not limited to, banks, thrifts, credit unions, broker-dealers, and insurance companies, having significant operations in the United States; and, upon the [Treasury] Secretary’s determination, in consultation with the Chairman of the Board of Governors of the Federal Reserve, any other institution he determines necessary to promote financial market stability.”