by Paul Kiel ProPublica, June 10, 2011, 10:22 a.m.

The Obama administration’s mortgage modification program is more than two years old. From the beginning, it’s been apparent that the participating banks and mortgage servicers were breaking the program’s rules. The administration has long argued it has little power to do anything about it. But now, after millions of homeowners have been rejected, the government has decided it’s finally time to crack down.

On Thursday, the Treasury Department announced it would be withholding government subsidies to the country’s three largest mortgage servicers, which are also among the U.S.’s largest banks: Bank of America, Wells Fargo, and JPMorgan Chase. The banks won’t be getting more money until they show “substantial improvement.”

“It’s important that the Treasury is acknowledging servicer noncompliance,” said Alys Cohen of the National Consumer Law Center, “but that’s been a problem for two years.” The action, while “better than nothing,” underscored the fact that many homeowners had been hurt during that time, she said.

Earlier this year, we reported extensively on Treasury’s lax oversight of the program, including its reluctance to penalize banks. Treasury gave us a variety of reasons for that reluctance: that the government’s power was actually quite limited, for example, or that if Treasury did penalize the banks, their performance would get even worse or they’d drop out of the program.

From almost the beginning of the program in 2009, Treasury has been sending mixed messages about its ability to penalize banks. In late 2009, Treasury warned in a press release that banks could face “monetary penalties and sanctions” for not abiding by the program’s guidelines. But a spokesperson later told us that Treasury didn’t have the power “to assess punitive fines or penalties.”

Asked today during a conference with journalists what took so long, Treasury official Tim Massad essentially framed the decision to withhold subsidies as not such a big deal. It was merely “a next step” in Treasury’s ongoing efforts to get banks to fairly evaluate homeowners’ applications for modifications, he said. As we reported earlier this year, Treasury’s oversight so far has mostly involved working with banks to get the problems fixed, and using carrots rather than sticks.

Massad also said Treasury hadn’t taken this step earlier because it only has the power to withhold incentive payments that are slated for completed modifications. Withholding incentives wouldn’t have made sense back in 2009, he argued, since so few modifications had been completed then. Treasury was making few payments at all to the banks.

It’s a confusing argument to make. There was a spike in permanent modifications in early 2010, leading to a jump in payments to the banks. Together, the three banks have collectively received $252 million in taxpayer incentives. None of those funds will be affected. Instead the government will be withholding payments going forward, which so far this year amount to a collective rate of about $19 million per month.

For banks the size of Bank of America, Wells Fargo, and JPMorgan Chase, which together reported $13.6 billion in profits in just the first quarter of this year, that’s not much of a penalty. Moreover, Massad said the payments would resume if the banks made the necessary corrections to their operations.

Treasury said there were problems in how the servicers communicated with homeowners and evaluated their modification applications. One measure, which gauges how accurately the bank calculated the income of homeowners in modifications, found that the three banks typically made errors about a quarter of the time.

Two of the banks pushed back against the findings. Wells Fargo said it was “formally disputing” Treasury’s assessment and argued that the government relied on outdated data that didn’t adequately reflect the improvements the bank had made in the past year. In particular, a Wells spokesperson said the bank’s internal reviews found that it was doing a better job of hewing to the program’s guidelines in calculating homeowners’ income.

A Chase spokesman said the bank disagreed with the assessment, but he stopped short of saying the bank would be disputing it. “We have made significant improvements since the modifications that Treasury reviewed and continue to work hard to keep improving our processes and controls.”

Bank of America’s spokesman said, “We acknowledge improvements must be made in key areas, particularly those affecting the customer experience” but said the bank had made “great progress.”

In addition to the subsidies to banks and mortgage servicers for providing modifications, the program also gives homeowners payments of up to $5,000 toward their mortgage. So far, about $206 million total has been paid out. Those payments won’t be affected by Treasury’s actions against the banks.