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Citigroup is in talks with the US government about increasing the amount of public ownership of the bank in a move politicians and bank bosses hope will avert the need for the ailing company to be fully nationalised. The crisis talks began after more than 20% was wiped off Citigroup shares in late trading in New York on Friday, leaving the business – which has assets on its balance sheet of $1.95tn – with a share value of $10.6bn (£7.4bn). The politically unpalatable move could see US taxpayers owning up to 40% of Citigroup and is likely to fan speculation that other struggling banks could be subject to similar creeping moves towards increased public ownership.

Fearful investors pounded most financial stocks yesterday, with the Dow Jones industrial average tumbling 251 points to its lowest close since 28 October 1997, and Standard & Poor's 500 index logging its lowest finish since 11 April 1997. All the major indexes slid more than 3%. "People left and right are throwing in the towel," said Keith Springer, president of Capital Financial Advisory Services."There's nowhere to hide any more," added Jim Herrick, director of equity trading at Baird & Co.

The US treasury department stressed that it remained committed to doing all it could to help the banking industry recover without taking outright control. In a joint statement with the "Because our economy functions better when financial institutions are well managed in the private ­sector, the strong presumption … is that banks should remain in private hands." Speculation that a major Wall Street institution could be taken into public ownership haunted the market last week with the likely targets seen as Citigroup and Bank of America. Bank of America lost almost half its share value in three days before rallying on Friday afternoon.

The latest talks are believed to be ­centred on a proposal for the treasury department to convert preference shares in Citigroup – received in return for recent emergency capital injections totalling $45bn and equivalent to a 7.8% stake – into new ordinary shares. Such a move would not involve additional taxpayer funds to prop up the embattled bank. However, taxpayers would surrender the guaranteed dividends that come with preference stock, and some degree of protection in the event of a corporate collapse.

Critical questions, such as the price at which new shares are issued, remain to be settled. Estimates of the likely size of the government's eventual stake range from 25% to 40%. Whatever the detail, such a move would see Barack Obama's administration become a major presence on Citigroup's ordinary share register, substantially diluting the interests of existing investors.

Such a move will heighten fears of political pressure being brought to bear on US banks. Analysts have suggested that banks relying on taxpayer bail-outs are already being encouraged to focus lending and liquidity on the US domestic market. Earlier, Vikram Pandit, Citi chief executive, tried to shore up morale at the bank by telling staff in a letter that he was still "very ­confident" about its prospects.

"Our Tier 1 capital base is very strong and is one of the strongest in the financial services industry. Additionally, we continue to focus and make progress on reducing the assets on our balance sheet, reducing expenses and streamlining our business for future profitable growth," he URL1 many measures, the bank has a near industry-leading cushion to absorb potential losses. However, steep declines in the bank's share price have heaped pressure on Pandit to seek further assistance from the government.

He first sought bail-out assistance last October, taking $25bn in exchange for preference shares. Six weeks later he returned to the treasury department and was given a further $20bn and a taxpayer pledge to protect the bank against most losses from a $300bn pool of assets. There is growing frustration with repeated piecemeal assistance to Citigroup, but yesterday the treasury reiterated its "determination to preserve the viability of systemically important financial institutions".

Market reaction to the talks was mixed. Ralph Cole, a portfolio manager at Ferguson Wellman "Even if shareholders get diluted, as long as the bank isn't nationalised there could be tremendous upside. " But Ben Halliburton, chief investment officer at Tradition "I'm not sure keeping alive companies that are potentially insolvent helps the broad economy and market over time.

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