Isn't that a good reason Microsoft doesn't want this to work? It will show open source as good.

I'm sorry, but no, Microsoft, and the world for that matter, do not work that way. Stifling open-source innovation in one small, small chunk of their bottom-line (and their gaming division is really small when compared to the behemoth that is the rest of MS) isn't even going to be on the agenda for discussion. They're stifling it because they want to control the content running on the platform (see any Apple product for why). Whether that is an acceptably smart/evil thing for MS to do is up to you, but let's not pretend it's part of the insidious crusade by the man to keep us hackers down, eh?

It isn't just open source. If I was to hack a driver for it, but not release the code and only do some sort of daemon server and documented API replicating anything it can already do, it would be the same idea.

The problem comes because the reverse engineer hackers don't have a business model to protect. It doesn't matter if that month long project doesn't return any money, because it was damn cool to do. Compare that to Microsoft who requires people to pay them money for the privilege to write code that takes advantage of it. I don't have any numbers, but a large group of small to medium game companies buy SDKs and Development tools for platforms they don't actually produce titles for. This is a significant number of people they don't want "trying" before they buy.