From Sl Wiki
Machinima, derived from "machine" and "cinema" (or "animation" - the jury is out on this one), is the name given to the art of making movies in virtual environments, and is by no means restricted to Second Life. Most online games and social environments incorporate facilties for capturing in-game video. The facility has been taken up by digital media film-makers and is now used not simply to catch raw, in-game action, but as a new narrative medium. It is unusual for the resultant films to exceed more than a couple of minutes, but the adoption of narrative - a storyline - has been a significant development of the artform.
In addition to the facilities provided with the virtual world software, there are third-party products for creating Machinima, usually offering superior capabilities. Examples include FRAPS (for Windows) and SnapzPro (for Mac). These tools are not necessarily that easy to use, so here is a tutorial (for MAC users) that you may find useful.
There is an annual Machinima Film Festival held in Astoria, New York (yes, the Real World) to recognise and celebrate the best in machine cinema.
For more information, Wikipedia has an extensive article on Machinima.