I just read your post to my mom and she flipped out, completely agreeing with you. Don't let the "but they're family" idea sway you. Family is still capable of doing terrible things, their status of relation doesn't matter. Go with your gut. What they did is all kinds of wrong. Kids that age are impressionable and will brag what they learned at school to their friends if they get a positive reaction from it at home from family or caretakers. You did the right thing and reacted the same way any sane, responsible parent should.

That being said, you don't want to burn a bridge so quickly. What they did was wrong. They are too set in old habits to change, but they need to respect how you raise your child. After a time apart, I'd allow then to babysit for only a few hours, to 'test the waters'. If they do the same thing again, outright ban them. They were irresponsible and disrespectful.