Yet language in the initial Xbox Live user agreement appears to allow Microsoft to do exactly that. It states: "Xbox Live may only be accessed with an unmodified, except for Microsoft authorized repairs and upgrades, Xbox video game console. Any attempt to disassemble, decompile, create derivative works of, reverse engineer, modify, further sublicense, distribute or use for other purposes either the hardware or software of this system is strictly prohibited."Microsoft is well within their rights, but the move leaves a bad taste in my mouth, especially since Microsoft had previously stated that they would be doing nothing of the sort with Xbox Live. It looks like all you'll lose out on is the right to use Xbox Live, so don't expect the FBI to be knocking down your door.
The agreement further states: "Microsoft may...retrieve information from the Xbox used to log on to Xbox Live as necessary to operate and protect the security of Xbox Live, and to enforce this Agreement."
Thankfully, it's unlikely the move will hurt the Xbox modding or hacking community at large. Mod chips can be turned off to play games on the Xbox Live online service, and chances are you'll have little interest in Xbox Live if you're using your hacked console as a Linux media player or web terminal.