To begin I put an offer on a house about a month ago, seller countered our offer but accepted another leaving us in second place. So we continued on with our house search, about a week ago got a call from our realtor that the 1st place bidder on the house back out. So we made arrangements to accept the sellers original counter offer. Counter offer was for full asking price, still below fair market value but home is a foreclosure and needs some major outside cleanup work. Here's the irony though- Last night we went out to dinner with some friends. Low and behold a friend of a friend was the original first place bid. What are the odds of finding your competing bidder at a table with you, and they are completely willing to talk!! The original winners bid was $3000 less than our original offer. Because we're accepting there counter we are now paying $4000 more than our original offer (that's right final total $7000 more than the original winners bid). Also to boot the reason why the orignal back out was due to an inability to get financing(not a large enough down payment) we have pre-approval for our financing and available 35% down if neccesary. The original bidder was going through the sellers agent, while we were using an independent agent. We are a little upset with the games being played here. We still have one signature to sign before our bid is officially complete, do we have any recourse. We still want this home, but are feeling a little bit angry with the sellers agent's ethics. I'd like to see him called out on the carpet for this one!

The sellers agent works for the seller and has the duty to obtain the highest offer for his client.
Your agent, unless they are a sub-agent to the seller, have normally the duty to get you the house for the least amount of money (buyers agent).
I would re-negotiate the purchase price if there is no firm contract.
Nothing the listing agent has done, looks like it's against the REALTOR COE to me, from what you described.

I guess I don't understand if the sellers agent has the obligation to their client to get the highest amount possible then why was our offer of 51,000 2nd place to an offer of 48,000? Granted in the offer of 48,000 he was both the sellers and buyers agent. But I really can't see the seller turning down more money in the interest of the agents buyer?

The seller will turn down more money in favor of:

Stronger financing offer or a stronger lender reputation
Less contingencies on the offer
Sooner closing date. Banks will take less for a sonner closing date.

If the agent wanted to be unethical and ensure that his buyer got the property, he simply would have "lost" your offer and it would have never been submitted for a counter.

Just based on what you have said, I don't see any violations.

"I guess I don't understand if the sellers agent has the obligation to their client to get the highest amount possible then why was our offer of 51,000 2nd place to an offer of 48,000?"

I should have said "highest or best offer", as REODayton pointed out.
Not knowing the offer details at that time, we are guessing why the seller accepted the other offer. Maybe the listing agent was giving a rebate to the seller? Anything is possible.