You cant do it on the phone, but on the computer (the free, but slower way)
use www. vixy.net
-copy and paste the address of the youtube movie
-choose: Converts to MP4 for iPod
-depending on how fast ur internet is, vixy will upload the file, convert it, then it'll say you can download it (total time usually 10 min for me)
add the file you downloaded into itunes, sync to phone.
Just saying it's easy enough to mail yourself the link from the video you catch on your iPhone to your desktop, making eWee's process a little easier.
you can save it in youtube.. when you are at that part of your phone there is a key for favorites and you can save it there... so when you open up youtube just go to that key.. and there it is.