Ouch...poor camera. Did you mean Gamebryo engine's limitation? Or was it the particular engine only for Oblivion? Because I think I have seen this possible in other games with Gamebryo engine.

Is there a way to modify this to work in Oblivion? I have seen techniques to stop rain under roof, I have noticed skeletons being manipulated, I have watched QQuix's weird but working conceptuals, but why not one for camera unfreezing conversation mechanism?

I've PM'd the author of the U3P mod over at TESNexus. Hopefully he can give us all some insight on the camera view limitations here on the Beth forums. If not, I would suggest posting some messages for U3P and GOW camera mods over at Nexus. Don't forget to endorse them if you like them. I'm sure that encourages/motivates authors to work harder on improvements.

Nope - Not a chance.