The move comes after Rick Wagoner, the former chief executive of General Motors, the largest US car maker, resigned amid reported pressure from the White House.
Obama said that the change was "not meant as a condemnation of Mr Wagoner, who has devoted his life to this company; rather, it's a recognition that it will take a new vision and new direction to create the GM of the future."
Al Jazeera's Rosiland Jordan in Washington said there was concern in some areas that the auto industry was being held to a much higher standard than the financial sector, which has received hundreds of billions of dollars in government aid.
The US president also admitted that the firms may have to go into formal bankruptcy procedures but said that both companies would survive.
|US auto sales have slumped amid a recession
and a global financial crisis [AFP]
"What I am not talking about is a process where a company is broken up, sold off, and no longer exists," the US president said.
GM and Chrysler had asked for another $21.6bn on top of the $17.4bn in emergency loans approved in December.
However Obama rejected the request, saying their restructuring plans did not go far enough.
"Neither goes far enough to warrant the substantial new investments that these companies are requesting," he said.
Obama also said GM and Chrysler unions and workers must also make more painful concessions to help the companies become economically viable.
The US president said Chrysler could get up to $6 billion in government loans if it completes the alliance with Fiat within 30 days.
Obama said the government would work closely with GM on its new business plan.
The United States would not let the auto industry simply vanish, Obama said, but that it must be retooled so it can survive without an "unending flow of tax dollars".
The companies employ more than 140,000 workers and the announcement means jobs are likely to be put at risk.
"There are jobs that won't be saved," Obama said.
"There are plants that may not reopen. There's little I can say that can subdue the anger or ease the frustration of all whose livelihoods hang in the balance because of failures that weren't theirs," he said.
Wagoner, who was at the helm of the largest US carmaker for eight years and who had said last week that he had no plans to quit, was asked by the White House to go, the US media reported.
A statement from GM said that Fritz Henderson, the company's chief operating officer and the architect of the carmaker's existing turnaround plan, will take over as CEO.
Wagoner had come under fire for his leadership of ailing company late last year when US politicians debated a bailout for the carmaker.
Ford, the other member of so-called "Big Three" US carmakers, has said it has enough money to survive the downturn without government aid.