Treasury Secretary Henry Paulson said that while many Americans may oppose government ownership of private companies, efforts to provide businesses and consumers access to financing were necessary.
"We regret having to take these actions. Today's actions are not what we ever wanted to do, but today's actions are what we must do to restore confidence to our financial system," Paulson told a news conference.
The deadline for banks to apply is Nov. 14 but Paulson said nine "healthy institutions" had already agreed to the plan.
The government will buy preferred, non-voting shares to acquire a maximum stake in each bank limited to $25 billion or 3 percent of risk-weighted assets.
Participating banks must accept limits executive compensation and what Paulson called a "ban on golden parachutes."
Half of the $250 billion will go to large banks, including Bank of America, Wells Fargo, Citigroup, JPMorgan Chase and Goldman Sachs, the New York Times reported. The rest will go to smaller banks and thrifts.
The plan to buy stakes in banks marks a shift from an early and much-debated plan passed by the U.S. Congress to use $700 billion to buy bad assets. The $250 billion for bank shares will come from the $700 billion, according to National Public Radio.
President Bush announced the plan on Tuesday morning, saying it was "not intended to take over the free market but to preserve it."
His address was followed by statements from Paulson, Federal Reserve Chair Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair.
The FDIC announced it would try to encourage inter-bank lending by guaranteeing 100 percent of the senior unsecured debt of banks and will guarantee all deposits in non-interest-bearing accounts, usually accounts held by businesses, until the end of 2009.
The resistance of banks to lend to each other -- a vital part of the financial system -- froze the ability of banks to lend money to consumers and businesses.
"The overwhelming majority of banks are strong, safe and sound," Bair said in a statement according to Reuters. "A lack of confidence is driving the current turmoil and it is this lack of confidence that these guarantees are designed to address."
After a dramatic rebound on Monday, U.S. stocks continued to gain on Tuesday. The Dow Jones industrial average climbed 132 points within the first hour of trading. The Standard & Poor's 500 Index was up 13 points.
The U.S. plan follows steps taken on Monday by several European governments, several of which bought shares of bank in their borders to encourage inter-bank lending. The coordinated effort by the European Union appeared to restore enough confidence in financial markets to help world markets regain some of their losses from recent weeks.