Can I just point out that this is not totally impossible. I mean, I doubt it myself, but perhaps there is a system where developers can chose exactly what gets installed onto the harddrive... I don't exactly know how this system has been put into place.
Anywho, harddrives provide faster access to content than what a DVD/CD/BD can, anyone who knows about computers knows this. It's why the PS3 has so many mandatory installs, and the 360 is bringing in this feature of optional installs.
Now, lets just say that Fable II had two texture sets, one for when people want to run the game off of the optical media, and one set for people running of the HDD. Running off the HDD is, as previously mentioned, faster, therefore the textures can be of greater size when it comes to streaming them, and moving them to the RAM. Bigger textures = higher quality = nicer graphics.
Now I am not saying that this is what is happening, I do not know whether the NXE allows for this, or whether Microsoft has released libraries for the devs to use which enables this. However, if the NXE did support this, Fable II is very much likely to be one of the first games to support it, as it's a relatively high hyped first party game which was only recently released.