I had fixed it a little bit ago. It was actually some older rails 2.3 code in my development.rb that was causing the issue. I copied over the code in my other rails 3 project and it worked.
Can you show how you are referencing the style sheets?
To get to the stylesheets directory, you only need to do:
Which will render the file: Rails.root / public/stylesheets/mysheet.css
I've cross referenced various files under the config directory with a fully working rails 3 application that I have. Double checked the script directory, which only contains the rails script. I am really running out of ideas here. Any ideas would be greatly appreciated.