Sounds like something that should work. Currently I'm searching the forum for initrd support which I'm currently 50/50 on if that works with the Pi.
So what you'd need to do is verify/build a kernel with loop support as well as the fs of your choice for your iso. The next step is to modify your initrd boot sequence to mount the iso as a loop device and then set the root device appropriately. I'd say its probably a slightly more advanced task to perform but nothing super difficult. Just a lot of trial and error.
Now one thing to note is that you'll have to do a little magic for making the iso r/w to allow for system updates. You'll also need to mount your /home to some other storage, an SD partition or some image file.
Links to forum discussion on initrd:
http://www.raspberrypi.org/phpBB3/viewt ... trd#p97835
http://www.raspberrypi.org/phpBB3/viewt ... 513#p41513