"The banks that are too big to fail are saying that 8 million Americans facing foreclosure are too little to count in this economy," said Senate Majority Whip Dick Durbin of Illinois, who spent weeks negotiating with lobbyists in a bid to strike a deal.
Obama long has backed the proposal to give debt-ridden individuals the option of asking a bankruptcy judge to reduce their mortgage payments. He cited that support last fall as he privately lobbied skeptical Democrats to back the $700 billion Wall Street bailout.
In February, he included the proposal as the stick in a housing plan full of carrots for the banking industry.
The House had passed the bankruptcy measure along party lines in a 234-191 vote.
The forced easing, or "cram-down," of a mortgage by a judge would have introduced additional uncertainty for investors, critics said.
Congressional Democrats also questioned the merits. "Do I want to have my rate go up so that somebody else might be able to cram down" their mortgage payment? asked Senator Ben Nelson, Democrat of Nebraska.
Spokeswomen at the Treasury Department and White House did not respond to requests for comment.
Obama supporters blamed the banks.
"There was a lot of fear-mongering," said Andrew Jakabovics, at the Center for American Progress in Washington. "The banks put on a good show, saying, 'Hey, if you force us to take more losses, we're going to go out of business.' "
Durbin said he would try again to restore the provision.
