(FORTUNE Magazine) – Even for a time of bitter harvests in Silicon Valley, longtime tech executive Eric Benhamou has had a particularly frustrating year. Benhamou is chairman of 3Com, a producer of data-networking gear, which has seen its share price cut in half since January on shrinking sales and a general tech malaise. He is also chairman of Palm, the maker of handheld digital assistants, which botched a product launch and reported heavy losses; its CEO resigned, and Benhamou had to step in as interim chief.

On the horizon of this gloomy landscape is a light that Benhamou and other tech leaders have been hoping would make life cheerier. Broadband service--always-on high-speed Internet connections via phone lines, cable, or wireless signals--would help computer makers sell faster machines and telecom equipment companies sell more network building blocks. It would reverberate through the economy, generating billions in new revenues while revivifying the tech sector.

Unhappily for them, the light isn't getting any closer. On the demand side, consumers are spooked by the high price of broadband service and uncertain about what exactly they would do with it anyway. On the supply side, startups that try to push the new technology seem to perish soon after they are born.

This has all been a tremendous letdown for the Valley, and so its frustrated executives are now busy looking for bad guys. There's nothing new in the Valley's target of choice: the federal government, always a popular whipping boy. The big surprise is the Valley's new ally; the story of how this concord came to pass is an unlikely tale of denial, scapegoating, and power politics.

Under normal circumstances, the high-tech community would instinctively vilify the regional Bell telephone companies. After all, these former monopolies, run by guys with names like Ed and Duane, are big and slow moving, like rubes with too much money--the antithesis of Silicon Valley cool.

Yet these days Benhamou and a handful of other tech leaders are the Bells' new best friends. They find themselves in the unusual position of pushing regulatory changes that would benefit the Bells, which just happen to be among the few telecom companies with money to spend on broadband. "The government can make a difference and not just stand on the sideline and watch this segment falter," Benhamou says, his quiet, even voice rising slightly. "If we manage to get it right, lots of sectors will benefit." A widely quoted study commissioned by Verizon, the New York-based Bell, suggests that widespread deployment of broadband could boost the U.S. economy to the tune of $500 billion a year, as Americans embrace online retailing, telecommuting, distance learning, and all kinds of other bandwidth-hungry services. Phone companies, small businesses, and even consumers would need to upgrade their systems, to the advantage of data-networking companies like 3Com.

By stumping for policy changes, though, high-tech companies are stepping into a quagmire. Ever since Congress attempted to reform the U.S. communications industry nearly six years ago, the process has been bogged down in lobbying, litigation, and posturing by the Bells, the long-distance carriers, the cable operators, and Internet players such as America Online (a unit of AOL Time Warner, parent of FORTUNE's publisher). As a result, consumers have seen little in the way of competition and innovation in local phone and data services.

Nowhere are these disappointments more obvious than in broadband. Fewer than 9% of American homes are signed up for high-speed Internet connections, compared with more than 30% of Korean households. Broadband has become a duopoly, with cable-television and local telephone companies providing service to most consumers. Things are usually good for duopolists, of course. Yet instead of accelerating their rollouts of high-speed service, some carriers, such as SBC, are pulling back, citing financial and regulatory uncertainties--even as they look to Washington to ensure that everyone from Manhattan to the Mojave Desert has access to fast Internet hookups. And fees for the service are going up, not down.

The federal government had plenty to do with the rise and fall of hopes for broadband. When Congress passed the Telecom Act of 1996, which was supposed to pave the way for competition and new services such as broadband, lawmakers were well aware of how hard it would be to build new local telephone systems to rival the Bell networks. Nevertheless, politicians stoked high expectations by offering wild prognostications about how quickly consumers would see more choices for basic phone service and cool new technologies--all of which have failed to materialize.

So Valley heavyweights are backing a smorgasbord of remedies. Besides easing rules that hem in the Bells, some executives endorse tax breaks for telcos that deploy broadband in rural areas. Speaking in October at the Federal Communications Commission, Cisco CEO John Chambers urged government leaders to adopt a national broadband policy to give all Americans access to high-speed links by the end of the decade. Intel Chairman Andy Grove recently outlined a proposal for a private-public research project to develop new telecom pipelines into the home. Broadband deployment, Grove says, "is a strategic issue that has an impact on U.S. security and the growth potential of the U.S. economy."

Still, high-tech types looking for a quick fix in Washington are likely to be disappointed. Lawmakers have other things on their mind these days; with Congress considering stimulus packages, a big broadband bailout isn't in the cards. Besides, the FCC, which reports to Congress and the White House on the state of communications competition, has been reluctant to declare broadband deployment a flop. That seeming denial of reality is partly due to the natural caution of a regulatory agency, but it also reflects FCC Chairman Michael K. Powell's pro-market philosophy. "Market failure might demand a government response," Powell said in a recent speech about broadband, "but market challenges should be left to market players."

Unlike other technology services, though, broadband doesn't operate in a pure market environment. All the major service providers in the U.S. are regulated in one form or another, and several players built their networks and dominant positions as protected monopolies. So it is impossible to get a handle on broadband without understanding telecom policy--a bloody battleground in which the Bells were pitted against the long-distance companies.

Congress drafted the Telecom Act of 1996 under an intense barrage of lobbying by the Bells, which won the right to start selling long-distance service as soon as they opened their markets to competition. Months after the bill passed--and following a period of equally intense lobbying by the likes of AT&T and MCI--the FCC issued a voluminous report directing the Bells to make their networks available to competitors at deep discounts. As analyst Scott Cleland with the Precursor Group, a Washington, D.C., research firm, says, "The Bells got the Telecom Act, and AT&T got the implementation."

The result has been a stalemate. Faced by the new regulations, the Bells balked, in a big way. They appealed the FCC's rules--and even questioned the agency's rulemaking authority--in various federal courts. At the same time, venture capitalists and Wall Street funded dozens of new companies that aimed to compete with the Bells. Many, including broadband startups such as Covad, Rhythms, and Northpoint, planned to use parts of the Bell network to deliver their services and got the FCC to make even more of the incumbents' physical plant available than its rules originally required.

Despite the favorable treatment, most of the broadband newcomers flopped, blaming the telcos for making their lives miserable. Stories abounded about the Bells' inability to transfer customers to competitors and their unwillingness to let rivals' technicians even use their bathrooms. But the competitors also failed to show profits just as Wall Street turned bearish. And when long-distance giant AT&T began acquiring cable-TV assets, the market cooled to any business model that relied too heavily on the Bells for network elements.

In fact, the cable companies, with their independent lines into the home, have emerged as the most successful providers of broadband service in the U.S. Cable modems account for about 70% of total broadband lines deployed. DSL lines represent about 28%, and satellite providers, which only recently introduced a two-way broadband system, have about 1% of the market.

Now the Baby Bells have shifted their focus of combat from long-distance rivals that have been weakened by falling prices to the cable modem players. Arguing that the cable companies have the lion's share of broadband revenues, phone companies are pressing for an end to those rules forcing them to lease their high-speed networks at deep discounts--networks that include routers, switches, and software, as well as new fiber connections to customers. The current arrangement has a chilling effect on investment, the Bells say, because they lose the chance to recoup their money every time part of their network has to be "unbundled" for use by competitors. "We can't spend billions of dollars of our shareholders' money when, for the most part, we don't know what the rules are going to be," complains Jim Ellis, general counsel for SBC, which operates in 13 states. "Why should we treat cable modems differently from DSL?" After all, the cable industry successfully fended off a mandate that it open its systems to competing Internet service providers.

The Bells' argument that all broadband players should be treated equally is gaining traction in Washington. While cable powers like AT&T oppose measures to help the Bells--"Broadband deployment needs no more incentives," says its chairman, C. Michael Armstrong--at least one bill, sponsored by Representatives Billy Tauzin of Louisiana and John Dingell of Michigan, seeks to free new Bell investments from the FCC's unbundling requirements. The Powell FCC, with its relatively laissez-faire bent, may well decide to relax the rules on its own.

One has to stand back and admire the Bells' political prowess. With employees in almost every congressional voting district, the local phone companies have always wielded considerable power on Capitol Hill. But they've also managed to build a broad coalition of support inside the Beltway and beyond. It is a testament to their strength that researchers from both left-leaning Brookings and the conservative Competitive Enterprise Institute support the Bells' push for deregulation.

The greatest evidence of their pull is that they've managed to win over many in the tech community as well. The lobbying effort began three years ago, when the Bells and computer industry heavyweights Compaq, Gateway, Intel, and Microsoft joined forces in appealing to the FCC for regulatory relief for the telcos. The initiative attracted little attention, and the proposal went nowhere, but it helped establish a foundation for alliances between the Bells and the tech world. Earlier this year, Intel endorsed the proposed rule changes to free the Bells' broadband investments from unbundling obligations.

Nonetheless, backing the Bells is uncomfortable for some tech executives. Though 3Com's Eric Benhamou favors the new rules, when asked whether he thinks the Bells would respond by rolling out broadband aggressively, he says, "No, I don't have confidence that they would." Similarly, while Intel's Grove is lobbying for the Bells in Washington, he is clear that he isn't happy with regulatory relief as the only option. "Advocating that is such an unsatisfying deal," he told FORTUNE. So he has also proposed a scheme to create competition for the Bells--a new research arm, funded equally by government and the private sector, that would develop low-cost alternatives to cable modems and DSL. He is doubtful that lawmakers, or tech companies for that matter, would cough up the money for such a plan. But, he says, "I came up with this proposal to say something different"--or to fire a shot across the bow of the incumbents.

It is telling that Grove, a well-regarded executive and strategy expert, admits to not knowing exactly how--or even if--telecom policy went wrong. Getting a handle on such questions may be one reason Intel recently appointed former FCC Chairman Reed Hundt to its board. Yet, Grove jokes, "I asked Hundt [about it], and I can't get a straight answer from him. I don't think he knows."

What, then, can Washington do to help? Some suggestions are intriguing--but not feasible. Bill Kennard, chairman of the FCC from 1997 to January 2001, thinks the best way to spur competition is to break up the Bells into wholesale and retail units, an idea that has been around for a while. Other ideas, while popular, seem laughably ineffectual. A proposed Senate bill that would grant tax credits to rural broadband providers allots a mere $425 million or so to the initiative.

At the very least, it's likely that the FCC or Congress will try to level the broadband playing field for telcos and cable companies. That probably means letting the Bells use their data networks as they see fit, just as cable companies can. And at some point the government simply has to get out of the way and let these big companies square off. "No telecom company can afford to write off the residential broadband market," says Deborah Lathen, a consultant and until recently the chief of the FCC's cable bureau. "The FCC should unburden the Bells and provide regulatory certainty. Then it will be time for them to show that they can compete."

The FCC should make sure all competitors have access to the truly scarce resource in the telecom network--and the one that would be most wasteful to replicate: the copper wires running from the customer to the switching center. After all, it makes sense that startups trying to offer the same services as the Bells over the exact same network as the Bells would fail; but those newcomers that use only the copper in the ground, while installing hardware and software that provide new and innovative services, should be given a fighting chance.

In the end, no one is blameless in this mess, least of all Silicon Valley, which wins the prize for disingenuousness. Broadband is in the news today because tech companies have made it a cause celebre. They anointed broadband as the Next Great Thing, and imagined that because of their benison and wise insight, all the institutional and competitive and regulatory impediments would fall away, and telcos and cable companies and regulators would magically start to move at Internet speed, just as tech companies do. Now they are shocked to discover that phone companies don't obey Moore's Law.

The irony is that sometimes the Valley moves at telephone speed. While casting about for a broadband fall guy and setting high expectations for a technology that inevitably will take time to mature, the Valley never bothered to develop cool applications that would jazz consumers to buy broadband in the first place. True, a few companies are trying to create applications that take advantage of fast data lines (mainly for videoconferencing and gaming), but most tech players are apparently waiting for high-speed networks to be in place first. According to recent research by Morgan Stanley Dean Witter, though, most consumers could buy broadband if they wanted to; 73% of U.S. homes have access to cable modems, and 49% are DSL ready. Yet only 12% of eligible households have found any reason to plunk down $50 a month for high-speed service.

So why hasn't Silicon Valley put its money where its mouth is? While Benhamou agrees that tech companies must assume a share of the blame, he says, "In general, issues of service deployment are secondary to the policy and financial considerations that drive infrastructure." In other words, he kicks it back to the regulators.

Needless to say, investors have plenty to gripe about too. Many of the DSL startups funded by venture capital firms had weak business plans, and they were unleashed on the public markets long before they were viable concerns, polluting the broadband waters.

Instead of lobbying Washington till their shoes wear out, computing and networking companies might be better served by redirecting some of their energy into R&D. Bringing down the price of broadband gear and creating killer applications that need high-speed connections to run with pizzazz would do more to fuel broadband than any government subsidy. New regulations won't make people buy something they don't want.

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