To answer your 4 questions:
That putty option to select and then right-click to paste in the best invention after the mouse. Is there anyway to make the terminal do this?
No, you can however select the text you want and drag-n-drop your selection to the command prompt.
Hack the source code?
Probably can be done through reverse engineering, but why bother for something so trivial, and the fact that it's illegal :P
iTerm as kbisset suggests.
Are the source code for the mac terminal public available?
No but iTerm's is