I'm fully behind you on this, however, when you sign up for live you pretty much give them the god given right for them to do whatever the hell they want.
You may have heard/seen the Internet Privacy Act of 1995 (431.322.12), signed by bill clinton, fully protecting users/sites from such hacking. Unfortunately this privacy act doesn't exsist and is just hog wash. I do believe such a thing should be introduced as what we do, or in your case haven't done to your xbox is no one's business but yours. I do think MS should be able to do whatever they want to people who peddle pirated games, but having an xbox that has a bigger hd, or a modchip isn't directly damaging MS's wallet.
There is some loop hole though, if you live in spain, where a case was thrown out of court due to some legal loop hole they have in their laws. There my be hope yet.