I just upgraded from OS X Lion to OS X Mountain Lion. My rails environment for the most part stayed in tact.
The only steps I had to do to get things back to a good
Mac comes with an outdated prebuilt PostgreSQL client installation and pg_config file that comes with it conflicts with any new PostgreSQL server & client installations.
Installing ruby gem with a fully qualified file name of pg_config overrides default known location of pg_config and installation succeeds.
Current location of pg_config by one click installer by EnterpriseDB: /Library/PostgreSQL/bin/pg_config
This command finally worked for me.
CrashMX2$ gem install pg -- --with-pg-config=/Library/PostgreSQL/bin/pg_config