Treasury Secretary Timothy Geithner told a congressional committee today that he will ask for the authority to create a federal receiver for “systemically important” non-bank financial firms.

Geithner did not say whether the primary regulator of large, troubled insurance companies would be a federal or state agency.

Geithner spoke at a House Financial Services Committee hearing on the $165 million American International Group Inc. retention bonus program.

The hearing was the second the House Financial Services Committee has held on the AIG retention bonus program.

Geithner plans to return to the committee Thursday to unveil a broad overhaul of financial sector regulations that will include the resolution authority request.

AIG’s problems “highlight the need for a resolution authority with the power to manage the orderly restructuring of a large, complex, non-bank financial institution that poses a threat to the stability of our financial system,” Geithner said.

The new resolution authority would be modeled on the resolution authority that the Federal Deposit Insurance Corp. already has over banks, Geithner said.

Geithner said his request for resolution authority would put limits on that authority.

“Before taking any emergency action, the Treasury secretary would need to determine that resolution authority is necessary upon the positive recommendations of the Federal Reserve Board and the appropriate federal regulatory agency,” Geithner said.

In addition to asking for new resolution authority over non-bank financial institutions, the Obama administration will be asking for tighter oversight and controls over previously unregulated entities such as hedge funds and private equity funds.

A source familiar with the administration proposal says Geithner will ask Congress to make the Federal Reserve Board the systemic risk regulator and the FDIC the receiver of institutions deemed too big to fail.

Derivatives and financial instruments would be regulated through clearinghouses, and all financial institutions would be required to have increased capital levels.

Federal Reserve Board Chairman Ben Bernanke also testified at the House Financial Services Committee hearing. Like Geithner, he called for the federal government to have “resolution authority” over troubled non-bank financial institutions.

If the federal government had had resolution authority over AIG , New York, in September 2008, it “could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders, and impose haircuts on creditors and counterparties as appropriate,” Bernanke said. “That outcome would have been far preferable to the situation we find ourselves in now.”

In addition, if AIG had been subject to consolidated supervision, it would not have been able to build up its subprime mortgage market exposure largely out of the sight of the company’s functional regulators, Bernanke said.

The Bonuses

Geithner and Bernanke also talked about their efforts to find out how to take legal action to stop the payment of the controversial retention bonuses to executives at the AIG Financial Products Corp. unit.

Both testified that their lawyers and AIG lawyers told them attempting to block the bonus payments could backfire, by triggering a Connecticut law that can double or triple the damages when employers lose suits of that nature.

Bernanke said he was told that the Federal Reserve Bank of New York “had conveyed the strong displeasure of the Federal Reserve with the retention payment arrangement.”

Dire Consequences

At the hearing, Geithner and Bernanke talked about why the government helped AIG.

The Fed, the Treasury and the New York Fed “agreed that the collapse of AIG could cause large and unpredictable global losses with systemic consequences — destabilizing already weakened financial markets, further undermining confidence in the economy, and constricting the flow of credit,” Geithner said.

Bernanke said the failure of AIG “could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.”

“Some of AIG’s insurance subsidiaries, which are among the largest in the United States and the world, would have likely been put into rehabilitation by their regulators, leaving policyholders facing considerable uncertainty about the status of their claims,” Bernanke said.

Another “worrisome possibility” was that uncertainties about the safety of insurance products could have led to a run on the insurance industry as a whole by policyholders and creditors, Bernanke said.

“Moreover, it was well known in the market that many major financial institutions had large exposures to AIG,” and that meant the failure of AIG could increase pressure on commercial and investment banks, Bernanke said.

State and local government entities held more than $10 billion in AIG bonds, money market mutual funds and others held $20 billion in AIG commercial paper, and managers of 401(k) plans had bought $40 billion in insurance from AIG against the risk of a drop in the value of stable-value funds, Bernanke said.

“In addition, AIG’s insurance subsidiaries had substantial derivatives exposures to AIG-FP that could have weakened them in the event of the parent company’s failure,” Bernake said.