diff --git a/builder.py b/builder.py
index 3d942a7..109fda5 100644
--- a/builder.py
+++ b/builder.py
@@ -1,32 +1,48 @@
 import sys, os, errno, stat
 import vars, jwack, state
-from helpers import unlink, close_on_exec
+from helpers import unlink, close_on_exec, join
 from log import log, log_, debug, debug2, err, warn
 
 
-def _possible_do_files(t):
-    t = os.path.join(vars.BASE, t)
-    yield "%s.do" % t, t, ''
-    dirname,filename = os.path.split(t)
+def _default_do_files(filename):
     l = filename.split('.')
-    l[0] = os.path.join(dirname, l[0])
     for i in range(1,len(l)+1):
-        basename = '.'.join(l[:i])
-        ext = '.'.join(l[i:])
+        basename = join('.', l[:i])
+        ext = join('.', l[i:])
         if ext: ext = '.' + ext
-        yield (os.path.join(dirname, "default%s.do" % ext),
-               os.path.join(dirname, basename), ext)
+        yield ("default%s.do" % ext), basename, ext
+    
 
+def _possible_do_files(t):
+    dirname,filename = os.path.split(t)
+    yield os.path.join(vars.BASE, dirname), "%s.do" % filename, filename, ''
+
+    # It's important to try every possibility in a directory before resorting
+    # to a parent directory.  Think about nested projects: I don't want
+    # ../../default.o.do to take precedence over ../default.do, because
+    # the former one might just be an artifact of someone embedding my project
+    # into theirs as a subdir.  When they do, my rules should still be used
+    # for building my project in *all* cases.
+    t = os.path.normpath(os.path.join(vars.BASE, t))
+    dirname,filename = os.path.split(t)
+    dirbits = dirname.split('/')
+    for i in range(len(dirbits), -1, -1):
+        basedir = join('/', dirbits[:i])
+        subdir = join('/', dirbits[i:])
+        for dofile,basename,ext in _default_do_files(filename):
+            yield basedir, dofile, os.path.join(subdir, basename), ext
+        
 
 def _find_do_file(f):
-    for dofile,basename,ext in _possible_do_files(f.name):
-        debug2('%s: %s ?\n' % (f.name, dofile))
-        if os.path.exists(dofile):
-            f.add_dep('m', dofile)
-            return dofile,basename,ext
+    for dodir,dofile,basename,ext in _possible_do_files(f.name):
+        dopath = os.path.join(dodir, dofile)
+        debug2('%s: %s:%s ?\n' % (f.name, dodir, dofile))
+        if os.path.exists(dopath):
+            f.add_dep('m', dopath)
+            return dodir,dofile,basename,ext
         else:
-            f.add_dep('c', dofile)
-    return None,None,None
+            f.add_dep('c', dopath)
+    return None,None,None,None
 
 
 def _nice(t):
@@ -104,7 +120,7 @@ class BuildJob:
             sf.save()
             return self._after2(0)
         sf.zap_deps1()
-        (dofile, basename, ext) = _find_do_file(sf)
+        (dodir, dofile, basename, ext) = _find_do_file(sf)
         if not dofile:
             if os.path.exists(t):
                 sf.set_static()
@@ -120,8 +136,8 @@ class BuildJob:
         self.f = os.fdopen(ffd, 'w+')
         # this will run in the dofile's directory, so use only basenames here
         argv = ['sh', '-e',
-                os.path.basename(dofile),
-                os.path.basename(basename),  # target name (extension removed)
+                dofile,
+                basename, # target name (no extension)
                 ext,  # extension (if any), including leading dot
                 os.path.basename(self.tmpname2)  # randomized output file name
                 ]
@@ -129,6 +145,9 @@ class BuildJob:
         if vars.XTRACE: argv[1] += 'x'
         if vars.VERBOSE or vars.XTRACE: log_('\n')
         log('%s\n' % _nice(t))
+        self.dodir = dodir
+        self.basename = basename
+        self.ext = ext
         self.argv = argv
         sf.is_generated = True
         sf.save()
@@ -168,10 +187,10 @@ class BuildJob:
         # redo-ifchange, and it might have done it from a different directory
         # than we started it in.  So os.getcwd() might be != REDO_PWD right
         # now.
-        dn = os.path.dirname(self.t)
+        dn = self.dodir
         newp = os.path.realpath(dn)
         os.environ['REDO_PWD'] = state.relpath(newp, vars.STARTDIR)
-        os.environ['REDO_TARGET'] = os.path.basename(self.t)
+        os.environ['REDO_TARGET'] = self.basename + self.ext
         os.environ['REDO_DEPTH'] = vars.DEPTH + '  '
         if dn:
             os.chdir(dn)
diff --git a/state.py b/state.py
index 37363ea..7798c70 100644
--- a/state.py
+++ b/state.py
@@ -261,7 +261,7 @@ class File(object):
 
     def add_dep(self, mode, dep):
         src = File(name=dep)
-        debug2('add-dep: %r < %s %r\n' % (self.name, mode, src.name))
+        debug3('add-dep: "%s" < %s "%s"\n' % (self.name, mode, src.name))
         assert(self.id != src.id)
         _write("insert or replace into Deps "
                "    (target, mode, source, delete_me) values (?,?,?,?)",
diff --git a/t/.gitignore b/t/.gitignore
index 60b3c7a..8b498e2 100644
--- a/t/.gitignore
+++ b/t/.gitignore
@@ -1,9 +1,3 @@
-c
-c.c
-c.c.c
-c.c.c.b
-c.c.c.b.b
-d
 test.args
 test2.args
 /passfail
diff --git a/t/all.do b/t/all.do
index b15b1aa..bc46f72 100644
--- a/t/all.do
+++ b/t/all.do
@@ -1,2 +1,2 @@
-redo-ifchange hello yellow bellow defaults-flat/all example/all
-
+redo-ifchange hello yellow bellow defaults-flat/all defaults-nested/all \
+	example/all
diff --git a/t/clean.do b/t/clean.do
index 3062fb3..5420ba8 100644
--- a/t/clean.do
+++ b/t/clean.do
@@ -1,5 +1,5 @@
 redo example/clean curse/clean deps/clean "space dir/clean" stamp/clean \
-	defaults-flat/clean
+	defaults-flat/clean defaults-nested/clean
 rm -f mode1 makedir.log chdir1 deltest2 \
 	hello [by]ellow *.o *~ .*~ *.log CC LD passfail silence silence.do \
 	touch1 touch1.do always1 ifcreate[12].dep ifcreate[12]
diff --git a/t/defaults-flat/.gitignore b/t/defaults-flat/.gitignore
new file mode 100644
index 0000000..580e8c9
--- /dev/null
+++ b/t/defaults-flat/.gitignore
@@ -0,0 +1,6 @@
+c
+c.c
+c.c.c
+c.c.c.b
+c.c.c.b.b
+d
diff --git a/t/defaults-nested/.gitignore b/t/defaults-nested/.gitignore
new file mode 100644
index 0000000..b656a9f
--- /dev/null
+++ b/t/defaults-nested/.gitignore
@@ -0,0 +1,15 @@
+/a/b/file
+/a/b/file.x.y.z
+/a/b/file.y.z
+/a/b/file.z
+/a/d/file
+/a/d/file.x.y.z
+/a/d/file.y.z
+/a/d/file.z
+/a/file
+/a/file.x.y.z
+/a/file.y.z
+/a/file.z
+/file.x.y.z
+/file.z
+/file
diff --git a/t/defaults-nested/a/b/default.y.z.do b/t/defaults-nested/a/b/default.y.z.do
new file mode 100644
index 0000000..648b3bb
--- /dev/null
+++ b/t/defaults-nested/a/b/default.y.z.do
@@ -0,0 +1 @@
+echo default.y.z $1 $2
diff --git a/t/defaults-nested/a/b/file.x.y.z.do b/t/defaults-nested/a/b/file.x.y.z.do
new file mode 100644
index 0000000..d11e86a
--- /dev/null
+++ b/t/defaults-nested/a/b/file.x.y.z.do
@@ -0,0 +1 @@
+echo file $1 $2
diff --git a/t/defaults-nested/a/d/default.do b/t/defaults-nested/a/d/default.do
new file mode 100644
index 0000000..162e667
--- /dev/null
+++ b/t/defaults-nested/a/d/default.do
@@ -0,0 +1 @@
+echo default $1 $2
diff --git a/t/defaults-nested/a/default.x.y.z.do b/t/defaults-nested/a/default.x.y.z.do
new file mode 100644
index 0000000..3b0398e
--- /dev/null
+++ b/t/defaults-nested/a/default.x.y.z.do
@@ -0,0 +1,2 @@
+echo default.x.y.z $1 $2
+
diff --git a/t/defaults-nested/a/default.z.do b/t/defaults-nested/a/default.z.do
new file mode 100644
index 0000000..02b313a
--- /dev/null
+++ b/t/defaults-nested/a/default.z.do
@@ -0,0 +1 @@
+echo default.z $1 $2
diff --git a/t/defaults-nested/all.do b/t/defaults-nested/all.do
new file mode 100644
index 0000000..7b789e5
--- /dev/null
+++ b/t/defaults-nested/all.do
@@ -0,0 +1 @@
+redo test
diff --git a/t/defaults-nested/clean.do b/t/defaults-nested/clean.do
new file mode 100644
index 0000000..5a76b40
--- /dev/null
+++ b/t/defaults-nested/clean.do
@@ -0,0 +1,6 @@
+exec >&2
+find -name '*~' -exec rm -f {} \;
+rm -f a/b/file a/b/file.x.y.z a/b/file.y.z a/b/file.z \
+	a/d/file a/d/file.x.y.z a/d/file.y.z a/d/file.z \
+	a/file a/file.x.y.z a/file.y.z a/file.z \
+	file.x.y.z file.z file
diff --git a/t/defaults-nested/default.do b/t/defaults-nested/default.do
new file mode 100644
index 0000000..790be20
--- /dev/null
+++ b/t/defaults-nested/default.do
@@ -0,0 +1,2 @@
+echo root $1 $2
+
diff --git a/t/defaults-nested/test.do b/t/defaults-nested/test.do
new file mode 100644
index 0000000..9ddcb7d
--- /dev/null
+++ b/t/defaults-nested/test.do
@@ -0,0 +1,36 @@
+exec >&2
+redo-ifchange \
+	file.x.y.z file.z file \
+	a/b/file.x.y.z a/b/file.y.z a/b/file.z a/b/file \
+	a/d/file.x.y.z a/d/file.y.z a/d/file.z a/d/file
+
+(cd a/b && redo-ifchange ../file.x.y.z ../file.y.z ../file.z ../file)
+
+check()
+{
+	if [ "$(cat $1)" != "$2" ]; then
+		echo "$1 should contain '$2'"
+		echo " ...got '$(cat $1)'"
+		exit 44
+	fi
+}
+
+check file.x.y.z "root file.x.y.z"
+check file.z "root file.z"
+check file "root file"
+
+check a/file.x.y.z "default.x.y.z file .x.y.z"
+check a/file.y.z "default.z file.y .z"
+check a/file.z "default.z file .z"
+check a/file "root a/file"
+
+check a/b/file.x.y.z "file file.x.y.z"
+check a/b/file.y.z "default.y.z file .y.z"
+check a/b/file.z "default.z b/file .z"
+check a/b/file "root a/b/file"
+
+check a/d/file.x.y.z "default file.x.y.z"
+check a/d/file.y.z "default file.y.z"
+check a/d/file.z "default file.z"
+check a/d/file "default file"
+