A new version of Rails was released today, and it appears that it has a problem installing on Windows. I was able to reproduce it, and I also found a workaround.
The workaround is to explicitly install the old version of Rails. You'd first have to uninstall each of Rails components that got installed before it blew up, but I think it would be easier just to start over and uninstall Ruby (either from the start menu entry or from add-remove programs).
Then reinstall Ruby and use this command to install Rails:
gem install rails -v 0.10.1
That worked for me. I will report this problem to the Rails team.