Using xterm does work - obviously I forgot to come back here and post about it! :)
Unfortunately, there's still one problem. I use bash on Linux, and I make heavy use of the ability to recall and edit commands. The feature works with xterm but it's display is fubar'd, making it hard to see if you've made the edit you really wanted.
I've posted about this in Apple's discussion forum but no, err, nibbles so far. *cough*
