Washington was last night considering fresh plans to clean up the US banking system’s deteriorating situation.

In an attempt to restore confidence within the battered financial sector, the incoming Obama administration and the Federal Reserve are discussing a range of options, reported to include a government bank that would buy up toxic assets. Funded by taxpayers, the “bad bank” would buy the assets blocking the system and instead place the risk of holding them on the government.

An announcement could be made within days of Barack Obama taking office as President on Tuesday.

The news emerged after one of the most dramatic days on Wall Street, yesterday, during which the US Government threw a lifeline to Citigroup and Bank of America that could leave American taxpayers on the hook for up to $373 billion (£254 billion).

Citigroup announced that it would split itself in two, while Merrill Lynch, which was taken over by Bank of America (BoA), reported a $15.3 billion loss for the fourth quarter. BoA made its first quarterly loss for 17 years.

Citigroup announced its fifth consecutive quarterly loss and hinted that the departure of Robert Rubin, the former US Treasury Secretary, who resigned as a director last week, would not be the last from the board.

The drama began when the US Government acted to put a floor under BoA’s plunging share price by agreeing to inject $20 billion into the group and to underwrite losses on a further $118 billion of its most toxic assets. The $20 billion injection will come from the US Government’s $700 billion Troubled Assets Relief Programme and will make the Government the bank’s largest shareholder, with 6 per cent. Any money that the Government pays to cover losses on the $118 billion portfolio of toxic assets that it has guaranteed will be funded separately by the American taxpayer.

An extension of this technique used to rescue Citigroup and BoA is another option being considered by President-elect Obama to shore up the battered financial system, according to The Wall Street Journal.

BoA also reported a $1.79 billion loss for the fourth quarter, against a profit of $268 million the year before. The result did not include the contribution of Merrill Lynch, which houses most of the newly merged group’s most toxic assets and produced a $15.3 billion loss for the fourth quarter, compared with a $10.3 billion deficit the year before.

Citigroup, which last year was still ranked as the world’s biggest bank, plans to split itself into two businesses: Citicorp will house its retail and investment banking operations while Citi Holdings will house the brokerage and asset management units.

The group declared an $8.29 billion loss for the fourth quarter, against an $8.9 billion deficit the year before, and disclosed its own government rescue package. That will mean that Citigroup absorbs the first $39.5 billion of losses on a designated $301 billion package of the bank’s most high-risk assets. The Government will assume 90 per cent of any other losses on those assets, which are mostly bad loans and securities backed by residential and commercial mortgages.

Citigroup hinted at further top-level changes to come at the bank, from whose board Mr Rubin resigned after criticism of his role in leading the bank to the brink of collapse. It would not comment on whether a reshuffle would include the departure of Sir Win Bischoff, its British chairman.

Citigroup’s shares ended 8.6 per cent down at $3.50 last night, having lost close to half their value over the previous two days. Shares in BoA closed down by 13.7 per cent at $7.18.

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