You nailed it. The problem isn't so much that they questioned the guys, although there would have been nothing wrong with them simply observing the situation and leaving. The problem was that they arrested them.
A more prudent course of action, if the officer was inclined to look into it further, would have been to say something like "look, there is no legal requirement for you to give me your ID, but we've been called out here by some ninny so we sure would appreciate it if you'd just let us know who you are."
Not that I'd want to make a habit out of answering LEO questions when I'm doing nothing wrong, but I'd be more inclined to respond to the request of a helpful officer than the demand of one acting outside his legal authority.
Well put...