Hosts file in OSX Lion not blocking as expected
One more thing to check - is the hosts file still in native unix format? It's quite possible within Nano to accidently save it as MSDOS or ye-olde mac format in which case it won't be parsed properly and just ignored

(This was originally an answer, but converted to a comment by a mod, and requested to be an answer again by the OP so they can accept it.)