The services will be taken over by the DfT's dedicated Operator of Last Resort (OLR) team and badged London North Eastern Railway (LNER) - reviving an iconic rail brand that Grayling said would continue once the partnership is in place.
The original London and North Eastern Railway was the second largest of the groups created by the Railways Act 1921. "Come on Chris, East Coast line today, the whole system tomorrow", he quipped. The main workshops were in Darlington, Doncaster, Gateshead, Inverurie and Stratford, London.
Services had been run by the DfT for six years up to VTEC taking over in 2015.
Mr Grayling, who has previously insisted there was "no question of anyone receiving a bailout", told Parliament that taxpayers had not lost any money "at this time".
Grayling had said late a year ago that the East Coast franchise run since 2015 by Stagecoach, which owns 90 percent alongside Virgin, would need to end early after lower than forecast passenger numbers led to losses of about £200 million for Stagecoach.
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".More news: Ford to Resume F-150, Super Duty Vehicle Production Within Days
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Virgin and Stagecoach won the eight-year ICEC franchise in November 2014 and began operating trains the following March under the Virgin Trains East Coast brand.
The government said on Wednesday it was scrapping the contract with London-listed Stagecoach five years early and would operate the line, which carries 22 million people annually, for two to three years before setting up a new public-private partnership. "We can not expect companies to take on unlimited liabilities otherwise they would not bid for franchises". The stock fell nearly 6 percent when Grayling said in February that the company would be ejected from a franchise originally due to run until 2023 after breaching a key financial covenant.
Grayling had been considering renationalisation of the line, as well as the option of a not-for-profit deal with existing franchise operators Virgin Trains and Stagecoach.
The company's subsidiary, East Coast Mainline (trading as Virgin Trains East Coast), is the current operator of the InterCity East Coast rail franchise under an agreement with the department for transport.
There are also likely to be raised eyebrows that despite their failure, Virgin Stagecoach will still be able to bid to run the line again after it is transferred back into public private ownership in 2020.
Following widespread criticism of Virgin and Stagecoach, Grayling has made the decision not to penalise the groups, saying an independent panel has found "no suggestion of either malpractice or malicious intent in what has happened". The timetable will remain the same.