I have the same problem on both Hardy and Gutsy.

I tried to run Xnest directly without going through gdmflexiserver
(Xnest -ac :3.0), and it exhibits the same behavior, except that
windows/sub windows are painted with their background color (for
example, windows become solid gray, textboxes become white). The only
exception is the desktop picture, which is repainted, but not the icons.

** Changed in: xorg-server (Ubuntu)
Sourcepackagename: gdm => xorg-server

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gdmflexiserver or 'new login in a window' doesn't refresh screen
https://bugs.launchpad.net/bugs/173837
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