NEW YORK (CNNMoney.com) -- Treasury Secretary Henry Paulson proposed a set of sweeping changes on Monday aimed at modernizing the nation's financial system in what could herald the biggest regulatory overhaul of Wall Street since the Great Depression.

The plan, which would broadly expand the Federal Reserve's powers, comes as concerns about the housing crisis and its fallout in the financial system continues to fuel calls for change in Washington. The Paulson changes, if enacted, would be largely invisible to consumers but would drastically alter how the financial services industry is regulated.

"Government has a responsibility to make sure our financial system is regulated effectively," Paulson said. "And in this area, we can do a better job."

But the Treasury chief was cautious to warn that changes could take "many years to complete."

Democrats, on the whole, slammed the Bush administration proposal. Senate Banking Committee Chairman Christopher Dodd of Connecticut called it a "failure of leadership" and argued that regulators are not taking advantage of the powers already at their disposal.

Among the plan's proposals is one that would grant additional powers to the Federal Reserve, essentially transforming it into a regulator that would stabilize financial markets.

The Fed, along with the Treasury Department, has attempted to shepherd the nation through the housing crisis and the recent turmoil in financial markets. Earlier this month, the Fed orchestrated a marriage between JPMorgan Chase (JPM, Fortune 500) and Bear Stearns (BSC, Fortune 500), which was on the verge of a collapse that threatened to send shockwaves through the broader financial system.

Under the Paulson plan, the Fed would essentially serve as a financial markets moderator, stepping in if the nation's markets were again threatened by an episode like the near collapse of Bear Stearns.

The plan would also give the central bank greater oversight of investment banks and previously unregulated entities like hedge funds and private equity firms that have wielded growing influence in financial markets in recent years.

Up to now, the Fed has played a important but much smaller role in the nation's financial system - setting the country's monetary policy and acting as one of the handful of regulators responsible for overseeing banks.

Streamlining agencies

The Treasury began examining the American financial system's ability to compete with maturing foreign markets about a year ago.

Since the last major overhaul in the 1930s, much of the change in the nation's financial system has been reactionary, with new regulatory agencies created in response to previous market crises.

Paulson, the former CEO and chairman of Wall Street powerhouse Goldman Sachs, said that as a result, regulators now find themselves duplicating each other's efforts, while other key regulatory issues slip through the cracks - a glitch the Treasury plan would hope to correct.

One suggestion involves combining the Securities and Exchange Commission, which ensures the functioning of financial markets and is responsible for protecting investors, with the Commodity Futures and Trading Commission, which regulates the trading of futures contracts of such key commodities as oil, gold and wheat.

The Treasury plan would also fold the Office of Thrift Supervision - the overseer of federally-chartered institutions that function much like banks - into the Office of the Comptroller of the Currency. The comptroller is responsible for overseeing national banks.

On the housing front, the plan would allow for the creation of a federal regulator for the mortgage industry, dubbed the Mortgage Origination Commission. The commission would aim to rein in the questionable practices of both lenders and brokers, who are now required to abide by a patchwork of state regulations.

In addition, the insurance industry could experience dramatic changes, under the plan. Insurance companies would now have the option to be regulated at the federal level, instead of the current state-run model, which has been in effect for more than 130 years.

"I am not suggesting that more regulation is the answer," Paulson said Monday. "I am suggesting that we should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change."

Act cautiously

Putting any part of the plan into effect, however, would require legislation, which could face a headwind with the nation in an election year and some congressional Democrats already showing hesitancy over the plan.

House Speaker Nancy Pelosi, D-Calif. said the proposal was "a step in the right direction" but urged more action.

Massachusetts Rep. Barney Frank, who chairs the House Financial Services Committee and recently proposed his own set of regulatory changes, said Paulson's proposal provided "an important service" but said he disagreed with some of its specifics.

"The plan goes too far in diminishing the role of the states, and not far enough in conferring needed new powers on the Federal Reserve over non-bank financial institutions for which they now have greater responsibility," Frank said.

Industry groups, which spoke in favor and against the plan over the weekend as its details became widespread, are likely to weigh in as well as the debate moves forward.

The Securities Industry and Financial Markets Association, which represents more than 650 financial services firms, called Paulson's plan "thoughtful" and "sweeping."

The Independent Insurance Agents & Brokers of America, which represents more than 300,000 independent insurance agents, brokers and their employees questioned the insurance component of the proposal, arguing that there are better ways to overhaul of the insurance industry without creating a "new federal bureaucracy."

In his speech, however, Paulson urged restraint, saying that enacting major changes could burden a market already under strain.

"These long-term ideas require thoughtful discussion and will not be resolved this month or even this year," he said.