A lot of this is a case of the tail wagging the dog.  Microsoft wants the PC to take on the role of home entertainment center; meanwhile the content providers have told them that the only way they will allow high-definition content to work on the PC is if Microsoft agrees to implement this draconian copy protection mechanism (an empty threat - unless the entertainment industry is actually willing to cut its nose off to spite its face).  Microsoft itself has little to gain from this, as they aren't the ones producing HD content, and they could end up losing customers and profits if people get angry and switch to Linux or other open-source platforms (or to Apple).  Now they could end up benefiting greatly if the entertainment industry ever actually succeeds in getting open source outlawed, but if it fails as it hopefully will the fallout could be disastrous if Microsoft finds themselves on the wrong end of the fight.

Microsoft knows that you can't stop a dedicated pirate.  From their perspective, product activation was quite successful - they managed to cut down on casual copying, as well as make things at least a bit more difficult for the hackers and pirates, but a dedicated cracker is going to find a way around just about any copy protection scheme you can possibly come up with.

And when you consider the sheer size of an HD-DVD movie, NOBODY is going to be trying to download one of those things - assuming that there is even someone out there with the hard drive space and bandwidth that they are willing to waste in order to share it.  Eventually that might change - I remember the days when downloading a single MP3 took half an hour (and you had to pray that your ISP didn't disconnect you - ahh the memories of dialup) - but I don't see over 8 GB of data ever becoming a trivial amount of data to download for a long time.