I can see activities being illegal, but not the currency or means of a measure of value being illegal.
Maybe it’s just that the Government doesn’t have a way to control or tax it yet and that bothers them.
I see two avenues of government attack. First, the government is required to create money and have it accepted for all debts, private and public. That's the competition angle. Second, and probably more important, bitcoin enables barter. Barterers are supposed to convert back into dollars and report income, but many don't. Wouldn't bitcoin make it even harder to track transactions?
So, if I were a greedy government rep, I would also accuse the exchange operators of fostering anonymous transactions and thereby facilitating illegal hiding of income on the part of their customers.