Washington declared yesterday that it would partially nationalise America’s biggest banks to try to avert the meltdown of the US financial system.

The extraordinary measure — part of the $700 billion White House bailout approved this month — represents the most drastic state intervention on Wall Street since Franklin Roosevelt forced the closure of banks during the Great Depression. “The efforts are designed to directly benefit the American people by stabilising the financial system and helping the economy recover,” President Bush said.

The precise terms are unclear, but the US Treasury is to use $100 billion (£57.4 billion) of taxpayers’ money to buy preference shares in nine banks. The investments will provide emergency funds to help the banks to continue to operate. Preference shares give investors more protection than that enjoyed by ordinary shareholders because they are paid first if a company goes bust.

In return, those banks have agreed to strict conditions, such as banning “golden parachutes”, where executives are paid to leave a company. The US Treasury will also monitor executive pay while it remains a shareholder and has the power to claw back remuneration it sees as excessive.

At the same time, federal regulators stepped in to guarantee any funds lent by one bank to another. It is hoped that that will encourage banks to start lending again and help the banking system to return to normal. At the moment it is almost impossible for an American to secure a car or student loan because the credit markets have frozen: banks are suspicious of their rivals’ secret exposure to bad debts, forcing institutions to borrow funds from central banks and hoard cash.

The White House move was immediately welcomed as one that could end America’s banking crisis. Stephen Schwarzman, head of Blackstone, one of the world’s biggest private equity firms, said: “We will be looking today to an absolute change in the global financial system in terms of liquidity.” He predicted that this could “break the back of the credit crisis”.

About $100 billion will be used to buy stakes in Citigroup, JP Morgan Chase, Goldman Sachs, Morgan Stanley, Wells Fargo, Bank of America, Merrill Lynch, State Street and Bank of New York Mellon. The remaining $150 billion will then be used to buy shares in other banks and financial institutions across America. Those banks have the right to buy back the holdings in three years’ time.

Such a move echoes the British bailout plan by which the Government took controlling stakes in HBOS and Royal Bank of Scotland, and threw a £37 billion cash lifeline to Lloyds TSB.

Not all the nine American banks wanted to sell stakes to the Government and some had sought to wriggle out of the deal. However, Henry Paulson, the Treasury Secretary and architect of the bailout, had insisted that each took part in the scheme to prevent any stigma emerging from the rescue plan. Mr Paulson, the former chairman and chief executive of Goldman Sachs, was worried that if only a handful of banks sold stakes, Wall Street would interpret the federal assistance as a sign that the participants could be on the brink of collapse, triggering a run on those banks.

Mr Paulson said: “Today’s actions are what we must do to restore confidence to our financial system.”

Pete Najarian, an options trader in New York, said: “This doesn’t feel very much like capitalism, but these are highly unusual times and this kind of drastic measure needed to be taken. None of the banks really wants the Government as a business partner but, given the circumstances, it was probably the only way to stop the unbelievable slide in the stock markets.”

Other banks outside the group of nine will have a month to join the Treasury’s capital purchase programme and must have elected to participate before 5pm on November 14.

The US Treasury will buy $25 billion in preferred stock in Bank of America (including Merrill Lynch, which was acquired by Bank of America last month), JP Morgan and Citigroup; between $20 billion and $25 billion in Wells Fargo; $10 billion in Goldman and Morgan Stanley; $3 billion in Bank of New York Mellon; and about $2 billion in State Street.

David Weiss, chief economist at Standard & Poor’s, the ratings agency, said: “This kind of capital injection is simpler to understand than the previous plan to buy troubled assets and it gets closer to the heart of the problem. The sale of troubled assets doesn’t improve a bank’s capital position, which is essential to enabling it to make new loans. The capital injection does.”

The Federal Reserve also said that it would help the short-term borrowing market by acquiring so-called commercial paper. Companies sell commercial paper, like a short-term bond, to raise money for items such as staff salaries. The FDIC, America’s bank insurer, said that it would also guarantee unlimited deposits in any non-interest-bearing US bank account. Those accounts are typically used by small businesses.

In New York the Dow Jones industrial average, which had surged on Monday, swung wildly as traders mulled over the terms of the federal bailout. It closed down by 0.8 per cent at 9,311.

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