It is the third time in less than a decade that a private operator has failed to complete its full term running services on the route.
Virgin Trains East Coast, a joint venture between Stagecoach (90%) and Virgin (10%), won the eight-year franchise to run services between London and Edinburgh in 2014.
In February, Stagecoach’s chief executive Martin Griffiths estimated the company’s total losses at £260m.
Transport Secretary Chris Grayling told MPs the East Coast was “not a failing railway”.
“Stagecoach and Virgin Trains got their bid wrong and they are now paying a price,” he said in a statement to parliament.
“They will have lost nearly £200m meeting their contracted commitments.
“This means taxpayers have not lost out because revenues are lower than predicted: only Virgin Trains East Coast and its parent companies have made losses at this time.”
Mr Grayling said the Virgin Trains East Coast contract would be terminated on 24 June and re-branded under “iconic” London North Eastern Railway (LNER).
It will effectively mean trains being run by the Department for Transport through a so-called “operator of last resort”, while a new public/private partnership is established.
He said he would consider plans “to enable employees to share directly in the success of LNER both as a pure train operator and subsequently as the new partnership”.
Mr Grayling told Sky News it did not mean the whole service was being nationalised, but hinted the business model could be mirrored elsewhere.
“This is the start of a process towards the future”, he said.
The Transport Secretary said there would be no sanctions against Virgin or Stagecoach for their failures, though Labour and unions criticised the decision to end the £3.3bn contract – saying it amounted to a bailout for the franchise.
Shadow Transport Secretary Andy McDonald said: “Franchising remains at the heart of the alleged partnership. No amount of tinkering can solve the failings of a broken privatised system, where the public takes the risk and the train companies take the profit, aided and abetted by the Transport Secretary.”
Rail, Maritime and Transport union general secretary Mick Cash said: “This is the second time that the Government have called upon the public sector to launch a rescue operation on the East Coast Main Line and instead of being a temporary arrangement Chris Grayling should listen to his staff and the public and make it permanent.
“After three shambolic private sector failures on the East Coast the message should now sink in that these cowboys cannot be trusted and should be locked out of the system on a permanent basis.”
ASLEF’s general secretary Mick Whelan, who represents trains drivers, called on Mr. Grayling to “bring the rest of our railways back into public ownership.”
He added when the franchise “was run it the public sector, it returned more than £1bn to the Treasury.”
Britains passenger and freight services were broken up and privatised in the 1990s. The government stepped in to run the East Coast line through the Directly Operated Railways between 2009-2015.