American media has been unfriendly to Muslims for years, and unfortunately, videogames are rarely an exception.
Generic Arab terrorists from unspecified - and possibly fictional - Middle Eastern nations are so common in modern games that they've almost become cliché. Sadly, that's just another example of popular media vilifying the Muslim world. But in Issue 269 of The Escapist, Saladin Ahmed says that the overly simplistic, broad brush depiction of Muslims needs to stop and a more nuanced and honest view needs to take its place.
But increasingly, as games have aimed for more and more supposed realism, the countries and villains depicted are real places where real people live. A truly realistic game would investigate the complexities of the conflicts they depict, and would show that the "hostile levels' of Iraq, Afghanistan, Yemen, Somalia, etc., are in reality countries where the vast majority of the population are civilians - women, children, and men just trying to live their lives without being blown to pieces. The aliens of the Halo franchise are more humanized than the bad guys in America's Army, who are really just endlessly spawning born-to-die vermin with AK-47s and rocket launchers.
Not every game is set on casting Muslims in a bad light however, and Ahmed cites a number of games that offer a more sympathetic view. Regrettably, these games are few and far between, but at least present a first step towards breaking the villainous Muslim stereotype. To learn more, read Muslims in My Monitor.