I believe she is saying: “The way they fold that flag....” and is in awe, not disgust.
I think she is saying that because she is impressed, as anyone would be. I think I read (obviously I’m not an expert on this sort of thing and was never in the military nor have I ever been to a military funeral) they fold the flag into 13 sections and it is done according to strict protocol.
This is an unfair attack on Mrs. Obama. Move on.
I think she said “look at the way they fold that flag..”
the reason is that if you have ever been to a military funeral, the flag folding is carried out flawlessly with great detail in handling. The gentlemen who folded that flag did not do nearly as well as the military burial detail and that is what she was commenting about.