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MS leaves no threat unturned.
Maybe you don't see what is happening as well as MS. The wildly popular iPod is connected to the broadly successful iTunes store, which used to sell just music, then TV shows, now movies. Then Apple announces "iTV" so that the iPod, the computer, iTunes, everything bought at the iTunes store, and every iPod owner's home entertainment system can be one big happy family. This is what was meant by the "iPod ecology".

If every happy iPod owner were to decide they wanted to be a part of this ecology just because of the iPod factor, then that would at the very least put a big dent in MS's plans for a digital home entertainment monopoly, and therefore dull the edge of every other MS product somehow connected to home entertainment.

I didn't know X-Box was bleeding money, but from the MS empire philosophy, they have no choice. They can't leave any potentially computer-related product alone that might make money for them or their competition. I assume this is what their shareholders expect.

This is what was meant by the "iPod ecology".

I'm well aware of what the iPod ecosystem is, and I'm well aware of things like marketing positioning and strategy. I'm not an idiot here. My point of contention is that even though consumers are buying into the iPod ecosystem, it's largely a market of accessories: the money is in cases, FM tuners, speaker systems, etc. These are markets Microsoft does not and should not care about.

What Microsoft should care about is whether or not iTunes runs on Windows. And hey, it does! That means people are using a Microsoft product to ensure the operation of their iPod. That's as far as Microsoft's involvement should go.

I didn't know X-Box was bleeding money

Microsoft has lost billions on the Xbox simply to gain a foothold. The 360 is faring no better for the company's bottom line. They've created a decent product, but can't move enough software to cancel out the loss on hardware.