Well, IMO there are "Good" Hackers and "Bad" Hackers. "Good" Hackers are people with great technical talent that can either modify, create, or in some other way change something (be it a piece of hardware - computer, car, etc. - or software, which could be the software that runs a PC, game console, or even your car) that may improve it's performance, usability, or asthetics (looks), and is not meant to be malicious or detrimental. A "Bad" Hacker is the same technically talented individual, with the exception of the intentions of their modification or creation - it is meant to be malicious, harmful, or detrimental in some way.
Modding the XBox is not really about making it the most technologically advanced thing in the world - it's partly about adding new features and capabilities to something that you use and enjoy, and maybe to satisfy a desire to "tinker", or learn/understand, or even "create".
It would be like adding a Holley 650 to your 1969 Camaro, and then adding dual exhaust, custom paint, custom wheels, a new stereo system, and rear disc brakes. Each of these modifications add to the car in some way - either adding power, looks, or usability. Is that wrong or against the law? No. Neither is hacking an XBox, computer, or alarm clock.
I will tell you what SHOULD be against the law - MS not letting you use XBL if you have a paid subscription just because you have a modded XBox. I notice that they have added it into the TOS for XBL (the unmodded XBox requirement).
How does it hurt MS?