I think the challenge here is to keep the UV mapping flat so that an unaltered flag image can be used as a texture map. My approach would be to create a flat flag, UV map it, and then fold it in the modeller. This might also offer the option of a 'flat / folded' morph (although values other than 0 or 1 would not be very useful!)

This page http://www.wikihow.com/Fold-an-American-Flag seems to show how it's done, although as a Limey I have no way of knowing if it's accurate. ;)

If that procedure is correct, I might be able to have a go at it.