Tim Geithner, the man whom Barack Obama has chosen as his Treasury Secretary, has apologised to senators for failing to pay $34,000 in tax dating back to 2001.

The gaffe is particularly embarrassing because as US Treasury Secretary, Mr Geithner would also be head of America's tax agency - the Internal Revenue Service.

Wall Street had cheered Obama’s choice when it was first announced, but the nomination has since generated some controversy. US stocks briefly turned negative this morning as tough questions during Mr Geithner's testimony raised some doubt about his confirmation. However, they rallied in late afternoon trading with the Dow Jones Industrial Index up 220.47 points to 8,169.56 as investors hoped the new administration would take decisive action to rescue the financial system.

Addressing members of the Senate Finance Committee, Mr Geithner said: "I have paid what I owed."

Mr Geithner, whose appointment has still to be voted through on Capitol Hill, explained that the error had been made when he calculated his own tax returns while working for the International Monetary Fund between 2001 and 2004. He said that he had not sought to deliberately defraud the US taxman but that the errors were "careless" and "avoidable".

He said that he hired an accountant to compile his 2003 and 2004 tax returns but that he did not "catch my error.”

He acknowledged signing an IMF statement saying he was aware that it was his responsibility to fully pay US Social Security and Medicare taxes.

He said: “I absolutely should have read it more carefully. I signed it in the mistaken belief I was complying with my obligations.”

Two senators told Mr Geither that their constituents had found it hard to comprehend how a future Treasury Secretary did not pay his taxes when they paid their own on a regular basis.

While Pat Roberts of Kansas sought to reassure Mr Geithner that despite the delay caused by the tax affair, he would still be confirmed to the post, he added that his phones were “ringing off the hook” from his constituents about the prospects of having a Treasury secretary who was careless in tending to his own tax liabilities.

Senator Charles Grassley of Iowa, the senior Republican on the panel, said of Mr Geithner: "To some he is not only the best choice, he is the only choice."

Mr Geithner, as president of the New York Federal Reserve, worked closely with Henry Paulson, the outgoing Treasury Secretary, in all of the Wall Street bail-out talks over the last six months and is perceived to have unrivalled experience to help guide America towards economic recovery.

Many lawmakers have complained that most of the over $350 billion committed so far has gone mostly to the banking industry, and has done little to help individual homeowners facing foreclosure.

Mr Geithner today said that the President and he were aware that the program needed “serious reform”.

“This is an important program and we need to make it work,” he said. “We’re going to keep at it until we fix it.”He said the still-evolving Obama economic plan would include a comprehensive housing package.

“In this crisis, our financial system failed to meet its most basic obligations,” Mr Geithner said. “The system was too fragile and unstable, and because of this, the system was unfair and unjust. Individuals, families and businesses that were careful and responsible were damaged by the actions of those who were not. “

Mr Geithner worked with Mr Paulson on attempts to bail out Lehman Brothers, the Wall Street bank which collapsed in September.

Mr Geithner's tax errors came to light when he was being vetted by security services - a mandatory process for anyone taking Cabinet office in Washington. The debacle has delayed the speed at which Mr Geithner could have been confirmed as Treasury Secretary.

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