I found this in About.com Urban Legends.
Analysis: There's no scientific basis for this old wives' tale, which dates at least as far back as the 1500s, when it was believed that distributing raw onions around a residence guarded against the bubonic plague. This was long before germs were discovered, of course, and a prevalent theory held that contagious diseases were spread by miasma, or "noxious air." It was apparently believed that onions, whose absorbent qualities had been well known since ancient times, could cleanse the air by trapping harmful odors.
"When a home was visited by the plague," writes Lee Pearson in Elizabethans at Home (Stanford: Stanford University Press, 1957), "slices of onion were laid on plates throughout the house and not removed till ten days after the last case had died or recovered. Since onions, sliced, were supposed to absorb elements of infection, they were also used in poultices to draw out infection."
In the ensuing centures the technique remained a staple of folk medicine, with application not only as a preventative for the plague, but to ward off all kinds of epidemic diseases, including smallpox, influenza, and other "infectious fevers." It even outlasted the concept of miasma, which began to give way to the germ theory of infectious disease in the late 1800s.
This transition is illustrated by passages from two different 19th-century texts, one of which claims that sliced onions will absorb a "poisonous atmosphere," while the other says onions can absorb "all the germs" in a sickroom.
"Whenever and wherever a person is suffering from any infectious fever," we read in Duret's Practical Household Cookery, published in 1891, "let a peeled onion be kept on a plate in the room of the patient. No one will ever catch the disease, provided the said onion be replaced every day by one freshly peeled, as then it will have absorbed the whole of the poisonous atmosphere of the room, and become black."
"It has been repeatedly observed that an onion patch in the immediate vicinity of a house acts as a shield against the pestilence," states the Western Dental Review, published in 1887. "Sliced onions in a sick room absorb all the germs and prevent contagion."
There is, of course, no more scientific basis for the belief that onions absorb all the germs in a room than for the belief that they rid the air of "poisons."