Im freaking out. My 5 yr old daughter put her hand down the pants of my neighbors 2 yr old daughter

Ive tried to make this short, but really want/need/appreciate input.
My heads in a whirlwind.  Im a single Dad with 50/50 custody and was at my neighbors tonight having dinner with them. They have a 2 year old daughter. Our kids were playing in the front room.  We noticed it got quiet.  So we checked on them in the living room where the toys are. Really quiet is usually not a good thing with little kids playing.  They were playing normal, but close together.  Their daughter went to use the potty soon after and I overheard their daughter say in her little 2 year old voice that my 5 year old daughter had touched her bottom.  My eyebrows and ears perked up instantly WHAT!???  I thought, and asked calmly what did she say?  She repeated it. I learned that their daughter calls her vagina her bottom as well. When I asked my daughter what happened she said "I dont know what shes talking about", started crying and instantly said she wanted to go home.  I tried not to freak and put a wall up on her side. I wanted her to communicate with me.  I calmly asked her what happened. She told me she put her hand inside their daughters pants, but wouldnt give a reason why.  When I got her to open up while she was explaining what happened she was shaking she was so upset. embarrassed, afraid I was going to be mad because 6 months earlier she and her 3 yr old male cousin (on her Moms side) were caught fondling each other under the covers.  We addressed it at the time explaining how it was very inappropriate and we thought that was the end of it.  Tonight she was adamant and she said that's the only time anyone has touched her privates was her younger cousin that one time??
I remember exploring as a kid, and have read some about sexual exploration in kids.  But in reality, I am in shock. I love her so much and really don't know what to think. my sweet little girl, I honestly feel a bit ashamed like I never have felt before. I hate feeling that way about her at 5.  My reaction is critical,  I don't want to create a sense of sexual insecurity in my daughter, I want her to talk to me and not create such a sense of fear in her by punishing her beyond merit in the situation. But I definitely do not want to be naive and let this to go by lightly or have it be brushed under the rug.
Is this normal psychosexual development? Normal Exploration for a 5 year old?  or Do I need to go down the path to see where there might be abuse happening? Yuk This is awful. Thanks for your input. concerned Dad

[skepticalpeach]

I understand your concern, especially as Dad; but have you spoken to her mother about this? I see you said you share custody, but you still need to come together to support and raise your daughter. You're still a team whether you want to or not.

Whatever you do don't make a big deal of it. Calmly explain to her that she shouldn't do that. My guess is that it was perfectly innocent exploration. Not appropriate, but innocent. If you are truly concerned you can always talk to your pediatrician about it, but I think it's something that can be dealt with at home.

Here's my blog about things like this:
http://www.medhelp.org/user_journals/show/320368/PSA-About-Little-Kids

[adgal]

I have to agree with Diva.  I doubt that there is anything to worry about, particularly since she told you adamantly that no one has touched her inappropriately.  It does sound like curiosity, or even just being silly.  I think this is probably a great opportunity to explain about private parts and that we don't touch others private parts, nor do we let them touch ours.  I heard it explained really well once...."if it would be covered by a bathing suite, then it's not for others to touch".  I would just leave it at that and not make a big deal out of it.  If it was something that was happening regularly, I would look into it further, but not for a single incident.  

[1LearningDad]

Thank you for your replies. Yes, We definitely do work together. I did not mean to come off saying (On Her side) like it was her Moms fault, I just wasn't present to witness or be a part of that incident with her cousin 6 months ago when it happened because she was with her Mom and not in my presence.  I spoke to several friends, and did some research.  I pray its innocent. I do feel it was curiosity, inappropriate but mostly innocent.  My concern that I need to address is that she knew it was wrong but still proceeded to act on her curiosity.  She lied at first acting like the little girl last night was making it up and immediately wanted to go home to get out of the situation.  I appreciate you comments very very much.  Her Mom and I only want to do best for her, and love her more than life.  She is our lives.  Thank you again. :)

[adgal]

You sound like a wonderful father.  I honestly wouldn't worry to much.  You'd be amazed at how often things like this come up on this forum.  Kids just do things without thinking it through.  Just keep the conversation very calm and matter of fact, then let it go.  I have no doubt she is perfectly normal.