The hidden rifts on Wall Street present Obama with his best chance to regulate the banks.

Congress's attempts to deal with the housing crisis this spring created surprising rifts within the financial industry, particularly between big banks and investors (at hedge funds and elsewhere). The two groups had started off united in their opposition--before the banks sold out their erstwhile allies and bargained for a better deal.

With Obama’s sweeping proposal for regulating Wall Street now moving to Capitol Hill--Barney Frank will push up to three regulatory measures through his House Financial Services Committee this month--it’s tempting to assume its fate will hinge on the balance of power between Democrats and the finance industry. But, once again, the industry is hardly monolithic. As with the housing bill, the far more relevant guides to what will survive the legislative funhouse are the ever-shifting tactical alliances between banks and other interest groups.

No single idea riles the big banks more reliably than the administration’s plan for a consumer financial products regulator, which would take the authority to tame abusive lending practices from the Fed (which also monitors banks' financial health) and house it in a separate agency empowered to protect consumers. Privately, the banks believe such an agency would crimp their profits on everything from credit cards to subprime mortgages. Publicly, they plan to argue that it would be inefficient--that it makes far more sense to have one regulator scrutinizing both their balance sheets and the products they sell rather than two operating "with half the information," as one Wall Street lobbyist explains it. The banks will also dwell on the paternalism of the proposal, suggesting that it is intrusive for the government to decide what kind of mortgage you can and can’t affix your signature to. According to the lobbyist, the banks are in the process of soliciting proposals from advertising firms for a “Harry and Louise”-style campaign--based on the commercial that famously slammed the Clinton health care plan for limiting choice and interfering in the doctor-patient relationship.

Alas, it’s hard to believe that the mortgage lender-homebuyer relationship occupies the same hallowed terrain in the American imagination as health care. Indeed, as the lobbyist concedes, “This is the hardest one. The political momentum to [create the agency] is there.” It is, in other words, the issue on which the banks could most use allies, but it’s far from clear that those allies will be forthcoming. The most promising potential sources of support are homebuilding and realtor groups, which could also see their bottom lines squeezed by a zealous consumer financial products regulator. But these groups have yet to weigh in.

Meanwhile, a person familiar with the lobbying efforts of money managers says investors are sympathetic to the new agency. Many investors in mortgage-backed securities feel they were victimized when the big banks originated mortgages that borrowers couldn’t possibly afford (or even understand), then sold them off in pieces on Wall Street. “Ultimately, there’s a massive information asymmetry here. The banks have much better information than the person they sell [the mortgage] to down the road,” this source says. “As an investor, you prefer that the loans be highly standardized, really safe.” The caveat is if the proposal were to go too far--say, by outlawing certain types of high-interest loans rather than just making them more transparent.

Another regulatory fight that could split banks and investors revolves around derivatives. A derivative is basically a bet on the movement of the price of an asset, like a stock or commodity. The reason derivatives proved so dangerous during the recent financial crisis is that they link financial institutions in an extensive chain. If one side of a bet--a so-called counterparty--defaults, it can roil not only the institution on the other side of the bet, but all the companies that institution has bet with, and the companies those companies have bet with, setting off a massive chain reaction. The one derivatives-related reform everyone more or less accepts is that, whenever possible, derivatives should be traded through clearinghouses. That is, rather than A betting with B, and B betting with C, everyone would technically bet with a deep-pocketed middleman--the clearinghouse. That way, if A were to default, it wouldn't bring down B and C; the clearinghouse would make good on their bets. The trick is determining which bets lend themselves to this arrangement and which don’t. (The banks want to exempt more exotic bets to minimize the regulatory hassle.)

A similar logic applies to the related concept of a derivatives exchange. In addition to the clearinghouse idea, many Democrats in Congress want derivatives traded in a transparent marketplace where anybody can see the terms of a particular bet and improve them if they’re so inclined. Investors generally love exchanges because more competition and transparency means they’re likely to get better terms for the bets they place (though the leading hedge fund group, the Managed Funds Association, takes a more nuanced view). The banks dislike them because exchanges erode their profits. So, while some of the banks have endorsed exchanges in principle, they will fight aggressively to limit the types of derivatives that must be traded this way. Says the lobbyist: “Billions of dollars are tied up in what’s plain vanilla”--that is, standard enough to trade on an exchange--“and what’s not.”

Of course, investors aren’t always the good guys in these reform efforts. For example, one possible point of contention between the two groups is the extent to which the government should oversee hedge funds (where many investors reside, and which are currently unregulated). The Obama proposal targets hedge funds in two ways. First, those large and complex enough to pose a risk to financial markets would come under the watchful gaze of a newly created “systemic risk regulator.” Second, Obama wants all hedge funds to disclose the contents of their investment portfolios to the SEC.

The first idea is almost certain to happen, and the hedge funds are basically resigned to it. As for disclosure, while the hedge funds have endorsed Obama’s proposal for SEC registration, the question is whether Congress will ask them to fork over additional information--and, if so, how much. (One hawkish idea is to force hedge funds to publicly disclose their “short” positions--that is, the stocks they’re betting against.) The big banks, which are heavily regulated themselves, wouldn’t be upset to see hedge funds burdened by more exacting standards. Not surprisingly, the hedge funds take the opposite view and are mounting a counteroffensive on Capitol Hill.

The thread running through all these fights is that Wall Street interests could probably defeat, or at least massively weaken, the administration’s proposals if the banks, investors, and other industry groups stood shoulder-to-shoulder. If the hedge funds were to help the banks gut the consumer financial products regulator, it’s hard to believe the banks wouldn’t reciprocate and help the hedge funds scale back whatever else Democrats have in mind for them. And yet, the early indications are that this sort of alliance-building isn’t happening. In late June, JP Morgan CEO Jamie Dimon published an op-ed in The Wall Street Journal in which he essentially endorses tougher regulations for hedge funds and mortgage brokers--his competitors--but expresses little enthusiasm for ideas, like exchanges, that could dent his own bottom line. Which is to say, the op-ed looks much more like a declaration of “every man for himself” than an exercise in realpolitik.

That’s good news for Democrats, who should be able to exploit these divisions. The question is why banks and investors would sabotage themselves this way. At the very least, you would expect the big banks to reprise their winning formula from the housing debate this spring--maybe wooing investors as allies for the fight against a consumer financial products regulator, then turning on them later in the process.

As it happens, that earlier episode explains why we’re unlikely to see this: Many investors were so embittered by the banks’ betrayal during the housing fight that they have little appetite for engagement this time around. These investors believed they were working alongside the banks, when in fact the banks were plotting to pass a provision the investors detested.

For their part, Congressional Democrats harbor similar hostilities. They feel as though the banks ran roughshod over them, after some initially hinted that they might accept the housing measure before abruptly turning against it. In the run-up to that vote, Dick Durbin, the Senate’s second-ranking Democrat, protested that the banks “frankly own the place.” According to The Wall Street Journal, a top bank lobbyist recently complained that Barney Frank told him, “Everybody hates you, and now they’re starting to hate me for hanging out with you,” and a senior House Democratic aide confirms that “there’s a lot of animosity for the banks.” In this context, you could hardly blame groups like homebuilders and realtors for letting banks fight the battle over the consumer financial products regulator alone.

The big wild card in all of this is time. Though Frank appears to be on an accelerated schedule to pass the reforms in the House, there’s far less activity in the Senate. People familiar with Chris Dodd’s Senate Banking Committee say the Connecticut senator will be tied up with health care over the next few months. In addition to chairing the banking committee, Dodd is the second-ranking member of Health, Education, Labor, and Pensions committee--and the de facto chair so long as his friend Ted Kennedy is battling cancer. (A banking committee spokesperson responds that the Senate leadership sets the calendar, but that “we are going to be ready to bring our bill to the floor as soon as Leader Reid can find us floor time. In the meantime we’re … meeting with stakeholders and holding hearing after hearing.”)

One financial services executive in contact with the banking committee estimates it will be late this year before the Senate turns in earnest to the regulatory agenda, and possibly early next year before it reconciles its version with the House’s. By then, the economy could have recovered, or the financial system could have lapsed into crisis all over again. More to the point, the banks could again enjoy a respectful reception in the corridors of Congress--or be everyone’s favorite whipping boy. But one thing they’re almost certain to be is still in the market for friends.

Noam Scheiber is a senior editor at The New Republic.