Sure you can overlap the menu on top of whatís below it,
Set <object param:
<param name="wmode" value="transparent">
and <embed :
Like you didÖThis will give you a transparent background for the .swf file (most of the time). Then use absolute positioning and an appropriate z-index in your CSS to force the underlying content up under the drop down part of the menu, which sticks out to the very edge of the dropdown part of the menu.
Here is a very rough draft of a site Iím working on which uses this principle. Forgive the rough nature, itís just a proof of concept design.