Overdrive has announced a new app to allow library ebooks to be read on an iphone (iPad and Droid support will come later). Although it's not available yet, you can see a sneak preview below.
However, for those of you who just can't wait, the new Bluefire Reader App works on the iPhone and iPad. And you can use the app for library ebooks. There are instructions from Bluefire and an excellent blog post at mobiputing.com with detailed instructions. That latter post has been updated with alternate ways of transferring the ebook files to your iPad/iPhone (emailing them to yoruself , or using Dropbox).
A staff member has tested this app and the instructions above to read ebooks from our Overdrive ebook site and said it not only works, it's pretty straightforward.