In reality, M$ can hire 3rd parties to make a game for them, an IP that is owned by M$. Nintendo does that a lot.

The big downside with weak 1st party is, that you're not able to put out an amount of games that serve only the purpose of selling systems and use the systems strength in full, you'll need to rely on the abilities of the 3rd parties.

Upside of course is, that when it's quieter gamesaleswise, you don't need to pay for the devs while trying to keep them employed and putting a stress on the companys profit.

First and second party titles always bring in more money than third-party titles. One of the reasons that Nintendo did rather well financially during the N64 and Gamecube eras is because of its first party titles.

In an era where third-party titles are going the way of the dinosaur due to rising development costs and the fact that neither the 360 or PS3 have large enough install bases to merit mass exclusivity, it's very important to have prominent in-house titles. If games like Gears Of War started going multi-plat, then MS would be in serious trouble.