Khatami began his second term acknowledging the setbacks to reformism in his inaugural address and tried to boldly make institutional changes that would strengthen his ability as president to enact his agenda. In October 2001, Khatami called on the judiciary to rein in its intrusions on press freedom and its campaign of arrests targeting reformists, especially parliamentarians who were supposed to have constitutional immunity. His pleas fell on deaf ears, and the judiciary summoned more than 60 reformist majles members to court in the following months, convicting four.

After biding his time for nearly a year, Khatami gave an address in August 2002 in which he reaffirmed that he was committed to establishing an “Islamic Democracy” in Iran that would uphold the rights of its citizens. Days after this speech, the majles would introduce “twin bills” that sought to reconcile the contradictions in the Iranian constitution between theocratic rule by the velayat-e faqih and republican rule by popular will. These “twin bills” were the last ditch effort by Khatami to change the trajectory of the Islamic Republic away from authoritarianism and total domination by hardliners by ensuring that reformists would have a viable path to competing in the Iranian system and a robust seat at the table when it came to policymaking. The first bill sought to limit the Guardian Council’s approval powers for candidates for office, while the second bill sought to clarify and strengthen the role of the presidency. This bill sought to enumerate the president’s powers to enforce the constitution and to give the president recourse to prevent institutions under the sole oversight of the Office of the Supreme Leader, such as the judiciary, intelligence and security services, and state-run media, from extralegal abuses of power.

The bills, which sought to limit the powers of the Guardian Council and Supreme Leader, would have to pass the Guardian Council, which was loath to cede its own powers. While futile, their introduction represented a symbolic stand by Khatami, demonstrating that he had exhausted all possible avenues of changing the system from within. The reformist-dominated majles passed the twin bills rapidly, but a two-year showdown then ensued as Khatami sought to negotiate a compromise with the unyielding Guardian Council. In May 2003, the reformists in the majles urged Khamenei to embrace republicanism to save the regime from itself, writing in a letter to the Supreme Leader, “We are deeply worried that the continuation of the present policies carried out by unelected men is taking us to a point of no return. … We must learn a lesson from the fate of the Taliban and Saddam Hussein and understand that despotism and selfishness is destined to take the country down to defeat.” Ultimately, Khatami withdrew the bills in April 2004 rather than allowing the Expediency Council to adjudicate, as their defeat was a fait accompli.

Khatami’s only leverage during this period was the threat that he would resign, which would have signaled that the reformists had lost faith in the legitimacy of the Islamic Republic regime. Khatami’s resignation would have likely catalyzed protests and again drawn the public into confrontation with the regime over losing its only semblance of representative government. Despite this looming prospect, the hardliners did not offer any concessions to Khatami to entice him to remain in his post.

During his second term, the IRGC’s leadership grew increasingly antagonistic toward Khatami and the reformists, especially after the majles introduced legislation to ban the IRGC from participation in the Iranian economy. IRGC commander Safavi warned in November 2002 that his forces were ready to unleash violence against reformist leaders and protestors if Khatami were to resign and stoke demonstrations against the regime. The IRGC viewed the reformists’ efforts to rein in their growing influence as an existential threat, drew closer to Khamenei, and supported authoritarianism in response. The IRGC would soon begin intervening in Iranian politics more directly than ever on the side of the principlist camp. During Khatami's second term, the judiciary also escalated its abuses, continuing with increasingly blatantly extralegal efforts to suppress the press and arrest prominent reformists who publicly backed the twin bills.

Despite Safavi’s warning, Iran’s reformist student population, which tended to be the most radicalized constituency opposing velayat-e faqih, engaged in continuous small-scale demonstrations during this period to pressure the regime to adopt the twin bills and to pressure Khatami and the reformists to be more assertive. Common chants at these protests included “Death to Dictatorship” and “Khatami, resign!” Whether due to pressure from the IRGC and other increasingly antagonistic hardliners or an overarching sense of duty to the Islamic Revolution and the regime, Khatami and the reformists in the majles disavowed the student-led protests.

Khatami’s disavowal confirmed that his ultimate loyalties were with the regime and not the public. Khatami and the reformist political establishment had succeeded in cobbling together a coalition of students, women, the cosmopolitan bourgeoisie, the urban poor, and ethnic minorities, but they failed at building organizational links to coordinate the aims and tactics of the political leadership with the base, the reformist media, and the burgeoning civil society. As a regime insider, Khatami feared a genuine popular movement would soon escape his control and challenge the entire system. As a result of this disconnect, Khatami declined to resign, and his only serious attempt to challenge Khamenei and the hardliners faltered.

Widespread disaffection, particularly among the students, set in. From Evin prison, journalist Akbar Ganji, who had gained increased prominence as a symbol of resistance, called reform-minded Iranians to engage in civil disobedience and electoral boycotts. The public’s disappointment in Khatami’s failure to deliver reforms led the pendulum of Iranian electoral politics to swing decisively in favor of the hardliners. In February 2003, as the “twin bills” floundered, Iran held its second round of municipal elections. Heeding Ganji’s call for boycotts, turnout was only 48 percent around the country, and in Tehran, only 12 percent of eligible voters cast ballots. Candidates affiliated with the conservative coalition won 64 percent of municipal council seats nationwide and, in a political earthquake, won every seat but one on Tehran’s 15-seat city council.

Aside from large numbers of reformists boycotting the elections, there were several other factors underpinning the rise of the conservatives. First was the Guardian Council, which had grown increasingly resentful of Khatami for trying to curb its powers. The Council members announced they had been too lax in their vetting during the previous majles elections and would be far quicker to disqualify candidates they did not like going forward. After their defeat in the previous four election cycles, hardline activists had begun devoting resources to making inroads with voters. A younger generation of non-clerical activists, typically from the far-right neoconservative side of the spectrum, under 50, and veterans of the Iran-Iraq War, grew frustrated with the older guard represented by Khamenei’s generation. These grassroots activists had taken over mid-level positions in various governmental sectors but were largely marginalized during the Rafsanjani and Khatami administrations. In 2003, they formed an umbrella group of political parties and organizations called the Alliance of Builders of Revolutionary Iran, or Abadgaran, to unify and organize the Iranian right. In Tehran, the Abadgaran-dominated council selected one of the organization’s founders, a firebrand who had served as its chief strategist and campaign manager, Mahmoud Ahmadinejad, to serve as mayor.

The Abadgaran proved adept at drawing out the vote from the IRGC, basijis, and their families. They were also able to win over the urban poor and working classes to their side, which had been a key constituency for Khatami. The reformists had come to be seen as an elitist movement of the middle and upper classes and intelligentsia. The working class tended to be more traditional and religiously conservative in their social outlook, but they still initially bought into the reformists’ economic promises of development and higher living standards. However, once in power, Khatami largely hewed to Rafsanjani’s neoliberal economic program, reducing subsidies and increasing privatization, which caused inequality to increase. Although the reformists were generally of the left, they were not a pro-worker, labor party. The Iranian labor movement grew increasingly militant and prone to strikes during Khatami’s terms in office over increased privatization, lack of protections for workers, stagnant wages, and efforts by businesses to shift to contract workers. The neoconservatives portrayed themselves as of the working class and adopted populist rhetoric in their campaigning, embracing the theme of social justice as inherently promised by the Islamic Revolution’s principles.