In its third attempt to prop up Citigroup in the past five months, the government will convert up to $US25 billion ($39 billion) in preferred shares to common stock. Existing shareholders could see their ownership of the bank diluted by 74 percent.
While the latest rescue does not inject more money into Citigroup, it gives the government more of a voting stake and far greater influence over the bank's operations, short of outright nationalization.
The White House said a higher US stake will help achieve a "better outcome" for the bank.
"The government is the new boss," said Mike Holland, the founder of money manager Holland & Co in New York.
"Every major decision is something that is not going to come out of Park Avenue, but is going to come from Washington, DC."
New York-based Citigroup in October and November received $US45 billion of taxpayer money, as well as a government backstop to cap losses on $US300.8 billion of toxic assets.
More than two-thirds of these assets related to mortgages and commercial real estate.
Shares of Citigroup closed down 39 percent on Friday, and touched their lowest level in more than 18 years.
The market value of what was once the world's most valuable bank has fallen to $US8.2 billion, Reuters data show, from a peak above $US270 billion roughly two years ago.
Citigroup CEO Vikram Pandit said senior executives "completely remain in charge" of day-to-day operations.
The bank will shake up its board and install a majority of new, independent directors.
"Investors want to see heads roll because they're so angry at the entire banking industry," said Marshall Front, chairman of Front Barnett Associates LLC in Chicago, which invests $US500 million.
"But Citigroup management is as well qualified to deal with the problems the bank faces now as anyone, and would not have the learning curve that new people would face."
Citigroup and other large U.S. banks will soon undergo "stress tests" to assess their ability to cope with a severe recession, and whether they might need more capital.
The Obama administration has said it prefers to keep banks in private hands, and Federal Reserve Chairman Ben Bernanke this week rejected 100 percent government control of lenders.
US stocks rally on rescue hopes
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Government’s proposal for banks comes today
