Banks 1, Investors 0

"Think of the new dynamic as a kind of Iran-Iraq war come to Capitol Hill: Where there are no obvious good guys, the next best thing may be two powerful rivals beating each other to a pulp.":

In fact, there are real differences among these species of moneymen. Top executives at large commercial banks tend to be a little older, a little stodgier, a little more politically conservative than their counterparts at hedge funds and other money-management firms. Traditionally, the bankers have also been far more sophisticated about navigating Capitol Hill. That's especially relevant in the current crisis, when the interests of the two groups increasingly diverge and Washington is being forced to adjudicate. And perhaps no episode better illustrates the gap in political savvy than the battle over housing legislation now boiling over in the Senate.

Ever since 2007, Congress has been grappling with a way to ease the millions of foreclosures piling up in the wake of the housing bust.

...Among the Democrats' preferred solutions to this problem is something called "cram-down"--that is, allowing bankruptcy judges to modify a mortgage and unilaterally impose the new terms. When Obama unveiled his own housing plan in February, he asked Congress to revive the cram-down idea as part of a carrot-and-stick approach to helping borrowers. The carrot would be cash incentives--a series of $1,000 payments--for banks to perform modifications. Cram-down would serve as the stick.

Almost immediately, investors and banks joined forces to snap that stick like a twig. Investors hated the cram-down idea because they worried judges would force them to accept, say, lower interest payments for the sake of distressed borrowers. The big banks had similar worries for the mortgages they keep. Many also hold on to second liens (basically, second mortgages) after they sell off the first and worried judges would wipe those out entirely. And both groups generally feared the arbitrary ways judges might wield their power.

But a funny thing happened while the big banks and investors were uniting against the cram-down push: The banks cut their own deal. Top executives at four large banks--Citigroup, Bank of America, J.P. Morgan, and Wells Fargo--descended on Congress to proclaim they'd love nothing more than to modify mortgages, just like the president wants. It's just that, with all those greedy investors out there, you never know who's going to sue. The solution, they argued, was a "safe harbor" provision: Give us legal immunity, and we'll modify all the loans you send us.

...From the banks' perspective, the beauty of legal immunity was that it would give them a free hand to modify mortgages owned by investors while collecting cash incentives from the government and protecting their second liens--a proposition potentially worth billions. From the investors' perspective, it meant the cost of modifications would come entirely out of their pockets.

...And so, while the investors droned on to glassy-eyed congressmen about the sanctity of their contracts, the banks waxed expansive about all they wanted to do for the man on the street. "The investors don't make a sympathetic case. The banks positioned themselves as happy to help modify the loans," says one neutral finance industry lobbyist. "By essentially throwing investors under the bus, they created a glide path for loan modifications."

When the House passed its bill in early March, the investors were stunned to see that it contained the safe harbor provision they feared and loathed.

...The investors realized they'd been had. They quickly pulled out of the broader lobbying effort and formed their own group--called the Mortgage Investors Coalition--which spent most of April frantically pleading their case. They argued that, even without safe harbor, the lenders had all the legal protection they needed. They insisted the only thing safe harbor would accomplish is to protect banks who made fraudulent loans, which they'd essentially be able to launder through modification.

...Alas, it may be too little, too late. Pressed by the big banks, the Senate defeated cram-down yesterday and is on the verge of passing safe harbor as early as Monday. (J.P. Morgan CEO Jamie Dimon was spotted in the chamber on Wednesday.) "We're trying to cram six-to-eight months of education into three-to-four week period," bleats one beleaguered investor lobbyist.