"It just seems like gambling," Donnelly said.
Geithner said he isn't so sure they should be banned or could be but that the government should instead ensure that banks have more cash reserves in place against such bets so the system won't collapse if the go wrong.
Rep. Maxine Waters, D-Calif. also asked about eliminating some financial instruments.
"Why are credit default swaps good products?" she asked.
Geithner responded that: "People will always innovate around government restrictions." He said it is better to "ensure that the institutions are strong enough to weather a very bad storm."
The financial crisis was caused in part because rating agencies and regulators simply did not understand or address the actions of the big banks and other players until they had already resulted in catastrophic losses.
Under the proposed new rules, investment companies would be required to have more cash on hand and take less risks.
The independent regulator Geithner is proposing would be separate from the Treasury Department and could come possibly from the Federal Reserve System. The aim is to end turf wars between the various government agencies tasked with overseeing the economy.
The regulator would have sweeping authority to examine any complex financial structure to assess its risks of going under and affecting the economy at large. It would oversee major insurance companies, hedge funds and financial derivatives markets.
The plan would also impose a uniform set of standards on large financial companies to limit their scope and risky activities.
The goal is to prevent another failure of a company like Lehman Brothers or insurer AIG and to limit exposure to the rest of the market if such firms were to topple.
Another goal is to prevent fraud such as those by admitted Ponzi schemer Bernie Madoff and accused scammer Allen Stanford -- grand-scale frauds that exposed major regulatory gaps and highlighted the need to strengthen enforcement and improve transparency for all investors.
The Obama administration is asking Congress to act quickly on its proposed reforms. Late Wednesday night, it sent Congress a 61-page bill that would give the government expanded powers to seize control of nonbank financial institutions. Rep. Barney Frank, D-Mass., the committee's chairman, has signaled that he could act on the measure as soon as next week.
The administration's tactic is in stark contrast to the Bush administration, which believed in less regulation and that the markets would set how much risk they should take on.
Obama's regulations aim to oversee companies not so much on the form they take -- bank, investment bank or insurance company -- but based on the type of transactions and business they conduct. A major criticism of the oversight structure to date is that insurance companies like AIG were involved in Wall Street's transactions but were supervised by traditional insurance regulators.
Two of the main targets for added oversight are credit default swaps and hedge funds.