I did and she told me you have to have a contract, no prepay/payg
Yeah, I heard they got rid of the pay-as-you-go iPhone option last year.
You could try activating/unlocking it yourself and put the pay-as-you-go SIM and see what happens.
http://download.ziphone.org/
I'm not sure what AT&T would think about this... I mean I'm sure that they wouldn't be thrilled if you told them, but I can't see how it would be a violation of their terms of agreement, or illegal. It's your phone, you paid a non-subsidized price for it and never signed or agreed to anything more than the EULA for the iPhone and iTunes (and if you don't like iTunes, you didn't even do the latter), if you unlock it that's your perogative (under the DCMA exception provision #4) and if you want to use it on AT&T's network, then about the worst that could happen would be AT&T telling you to stop and use a different phone... which is where you are right now anyway.
In fact, AT&T says they have an open network - "the most open network":
http://www.usatoday.com/tech/w...s/2007-12-05-att_N.htm
AT&T CEO Ralph de la Vega's said "You can use any handset on our network you want... We don't prohibit it, or even police it. ... We are the most open wireless company in the industry."
The DMCA says you can unlock your phone, and AT&T says they will let you use any compatible handset on their network. I don't see the reason not to unlock. Unless you are doing this with a 3G iPhone, but you can't even get one of those without a contract.