I don't do music on the bike, partly because it's too much trouble. When I get on the bike, I need to make sure I have my keys, my lock, the stuff I need at my destination... don't want another thing. Music doesn't work too well with the whole slowing-down-my-life thing. I don't want to be doing several things at once all the time. Biking can be a great time to just decompress, and I like to enjoy whatever quiet the city allows me.
From a safety standpoint, though, I don't see a huge problem with headphones. I'd prefer ones that don't go in the ear, but even ones that do plug the ear seem as good for letting sound through as the walls of a car. (the noise of one's own car drowns out the sounds of road hazards some, too.)
If I were a little more concerned about safety I'd buy a rear view mirror. My ears don't tell me where things are behind me.