In Firefox 3 and later (and probably older versions), selecting content within an iframe always seems to use the grey selection background colour used for a document that doesn\
I just tried to reproduce the problem with a "real" page as iframe content and then it works like you want: blue colored selection! (FF 5.0)
see: http://jsfiddle.net/97Vjz/8/
It seems only generated content has this problem, so you could make a page (php/asp(x)) that generates the content for you to circumvent the problem.
Another solution to use javascript generated content is to load it with src="javascript:'<html />'"
(actually this is Tim's own solution from the comments below.)
A simple example script: http://jsfiddle.net/97Vjz/9/
iframe.src='javascript:\'<html><body>' + content + '</body></html>\'';
Hypothesis: It seems that for dynamically written iFrames, either a XUL Iframe is rendered or the Gecko engine doesn't honor the styles.
Short of submitting a bug, the only workaround I can see is to wrap our contents in a textarea
and style it to make it 'invisible': http://jsfiddle.net/mrchief/YYXSY/19/
There is a property of the iframe exposed in Firebug's DOM inspector contentDocument->designMode
which is set to false for you iFrames. Forcing it to true through the DOM inspector enables the blue highlight you're after.