Something Jakob Nielsen suggested two years ago is starting to roll out: password masking is slowly starting to go away. Lands’ End, which gave their checkout process a stunning overhaul, is one example.
This has been a feature in OS X for a while; the wi-fi login prompt has a show/hide checkbox:
Until more people are comfortable with unmasked passwords, this is a nice way to handle the problem: offer an explicit show/hide toggle. Once users get past the initial surprise of having their password in plain sight, I believe they’ll see its advantages.