I posted to the Audacity forum and got some interesting feedback:
http://forum.audacityteam.org/viewtopic.php?f=18&t=14014&sid=f29a500ddd4aee4cad4084becaa2fb6e&start=10

Apparently, the problem is partially fixed on the trunk, i.e., the xrun-
recovery code has been improved so that recording will not stop.
However, the underlying latency problem has not been fixed, so there is
a risk of defects in the recorded audio.

In the thread, I learnt how to configure loopback using the PulseAudio
tools. User-interface-wise that was not a pleasant experience, but now I
know that it is possible. However, unless Ubuntu makes an effort to make
PulseAudio easier to configure, software playthrough in Audacity is a
necessity.

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https://bugs.launchpad.net/bugs/355846

Title:
  audacity stops recording after about a second when using software play-through

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