"Look, I am not interested in punishing banks, I'm interested in protecting our economy," he said.
Obama proposed taking $30 billion of the money repaid by Wall Street banks and directing it to community banks to allow them to lend to small businesses.
A popular president, Obama has spent a year's worth of political capital on what has turned out to be an unpopular agenda. Tonight's address offered a chance for him to outline what he hopes to do in his second year to get the economy back on track and reconnect with Americans.
With Republican victories in recent elections in Virginia, New Jersey and Massachusetts -- Obama won in the 2008 presidential election -- the president's agenda has, to a degree, been rebuked by the voters.
"I have not detected a level of anger and cynicism about the federal government in my lifetime as high as it is today," said Sen. Evan Bayh, D-Ind.
Obama sought to appeal to voters by discussing programs that will help them directly, including nearly doubling the child tax credit, helping with student loans and developing ways to help the job market improve.
The president stressed that his administration cut taxes last year for working families, small businesses, first-time home buyers and Americans paying for college.
Obama called for a tax credit for small-business new hires, the elimination of capital-gains taxes for small-business investments and an extension of tax cuts and credits for the purchase of new equipment or facilities. Treasury Secretary Tim Geithner and Small Business Administrator Karen Mills will be the point people for the new proposals.
The administration is facing mounting pressure to do something about the rising national debt, which has become a political liability. The latest ABC News/Washington Post poll found that 56 percent of Americans disapprove of Obama's handling of the federal budget deficit.
Among independents, who have flocked to Republicans in recent elections, the president fares even worse, with 2-1 disapproval.
In a move that is raising alarms among many liberals, Obama proposed a three-year freeze on domestic spending not related to national security or entitlement programs like Medicare.
"Like any cash-strapped family, we will work within a budget to invest in what we need and sacrifice what we don't. And if I have to enforce this discipline by veto, I will," the president said.
The freeze saves $250 billion over 10 years -- less than 1 percent of what the government spends.
"It's only one of the things that we're going to be doing, but it's nonetheless important. It's important to draw a line somewhere," said Peter Orszag, the director of the Office of Management and Budget.
The decision has drawn heat from liberals who questioned the president's priorities.
"If people are hungry, you want to make sure that we're spending appropriately so that nobody goes hungry," said Sen. Bernie Sanders, D-Vt., who sits on the Senate Budget Committee. "If we're spending money on weapons systems that are no longer relevant in the fight against terrorism, you want to eliminate that."
Obama acknowledged concerns from his own party that the government cannot freeze spending in tough economic times.