CNAME browsing from the server

We recently migrated all our applications from an old set of servers to a new
set. As part of the migration, we needed to keep both sets up and running so
we started a new naming convention for the new servers. Migrations were
successful except for 1 application.

This application has hardcoded into it, lines of code that search for the
OLD server name. So let's say it was called server1 and the new server is
let's say, server2. Since we couldn't change the application's code, after
the migration, we removed server1 from the domain and cleared out any DNS
entries for it. We then created a CNAME record of server1 to point back to
server2. We then made a few regedit changes on server2 which allows Windows
servers to accept incoming requests from both the actual computer name and
the CNAME.

When you browse to server1 remotely from a workstation (i.e. -
\\server1\share), it works fine. It brings me to the share on server2 as
expected.

HOWEVER, if I use the CNAME from the server itself, it doesn't work. It
asks for login credentials and regardless of whatever domain or local
administrative account we enter, it rejects all logins. We think this is the
reason why our application is failing. When the application is invoked on
the server, the code is looking for the name, server1. Despite the presence
of a CNAME, because it is not server1 but is actually called server2, the
application won't run. Because of other reasons, we cannot change the name
server2 to server1. We need to keep server2 as the name.

So again - browsing to server2 remotely using the CNAME, server1, works just
fine. From the server itself, the CNAME will not work. We have tried
editing the hosts file to have the CNAME point back to 127.0.0.1 and we tried
to say CNAME points back to this server's IP address as a wild stab. That
didn't work either.

Help!!!!!!
Thanks,
-Ji