Henry M. Paulson Jr., the former Treasury secretary who led the response of President George W. Bush's administration to the 2008 financial crisis, on Thursday endorsed calls for greater scrutiny and regulation of capital markets. In testimony to the Financial Crisis Inquiry Commission, Paulson called the regulatory system that he confronted from 2006 to 2009 'archaic and outmoded.' The commission, which is examining the cause of the financial crisis that pushed the country into recession, has a Dec. 15 deadline to report to Congress. Paulson said that when he started as Treasury secretary, he saw 'huge gaping holes' in the regulatory system, and he tried to identify regulatory gaps and revive long-stalled reform of the mortgage finance companies, Fannie Mae and Freddie Mac. But Paulson admitted: 'Most of the toothpaste was out of the tube, and there really wasn't the proper regulator apparatus to deal with it.' The financial reform legislation being debated in the Senate would direct regulators to require higher capital and liquidity for financial institutions -- a step that Paulson endorsed. 'Everybody talks about capital, but to me the biggest lesson I learned out of all the crisis was the lack of focus by so many market participants and by regulators on the importance of liquidity,' he told Bill Thomas, the commission's vice chairman. As a former chairman and chief executive officer of Goldman Sachs, Paulson faced skeptical questions about the so-called shadow banking system, the network of investment banks, insurance companies, hedge funds and other institutions that largely went unchecked by a regulatory system designed to focus on deposit-taking banks. 'A number of times, I have said that I believe that we had excessive complexity in financial products and that, as I think about it, it's very hard to regulate against innovation,' Paulson told Phil Angelides, the chairman of the commission. Paulson showed little sympathy for the argument that colossal financial companies -- which have grown only larger since the crisis -- should be broken up. 'The level of concentration where we have 10 big institutions with 60 percent of the financial assets, this is a dangerous risk,' he said. 'Now I believe these institutions are necessary. They perform a valuable role.' He added that there needs to be better regulation, as well as more consistent -- and bigger -- capital and liquidity requirements. 'But then I come to the conclusion that regulation will never be perfect,' Paulson said. 'There will continue to be failures. There have been since the beginning of time. Since the time we've had capital markets, institutions have failed, we've had financial crises.' 