Rails Connect with Postgresql database in application ubuntu

I am using ubuntu 12.04 and rails 3.2. I am creating a rails application in which I'm using PostgreSQL databse. I installed postgresql using the following command:

sudo apt-get install postgresql

for reference i checked out https://help.ubuntu.com/community/PostgreSQL. Later I created the user postgres and set the password postgres using the following command

sudo -u postgres psql postgres
\password postgres

Next I created the database using:

 sudo -u postgres createdb mydb

I tried to connect with Postgresql with the username postgres and password postgres and got successfully connected with the following command:

psql -U postgres -h localhost
Password for user postgres:
psql (9.1.4)
SSL connection (cipher: DHE-RSA-AES256-SHA, bits: 256)
postgres=#

In my rails app my database.yml has the following code:

development:
 adapter: postgresql
 encoding: unicode
 database: mydb_development
 pool: 5
 username: postgres
 password: postgres

test:
 adapter: postgresql
 encoding: unicode
 database: mydb_test
 pool: 5
 username: postgres
 password: postgres

production:
 adapter: postgresql
 encoding: unicode
 database: mydb_production
 pool: 5
 username: postgres
 password: postgres

Now when I run the command rake db:migrate i get the following error:

rake aborted!
FATAL:  Peer authentication failed for user "postgres"

I tried adding host: localhost to database.yml for each environment and i get the following error:

rake aborted!
couldn't parse YAML at line 28 column 0

The line 28 is

development:
 adapter: postgresql
 encoding: unicode
 database: hackathonio_development
 pool: 5
 username: postgres
 password: testing
 host: localhost {This is line 28}

Please help me figure out a solution for this..