I work for (I guess I should say DID work for as I'm on my two week notice...job laid off half of us last week) a small game company that makes free to play games for the PC. We have a loyal following but not NEARLY enough to entice advertisers in this economy into spending money for ads in our games.
We don't use the most recent engines. But we use a very stable and powerful one for what we do. And lemme just say that free gaming, while possible will never have the quality of a large budget console or pc game. Just not enough money to pay enough programmers/artists/testers...etc.