Thanks for the update.
Observer mode already contains two possible exploits (walking through walls and flying). Of course, both of those would be easily seen by other players. Seeing through walls is indeed more complicated because it's not as obvious.
I hate to use the ol' NRA argument, but "if seeing through walls is a hack, then only hackers will be able to see through walls." Apparently, any one who wants to wall hack now can do so pretty easily. Giving everyone observer-mode wall hacking powers will help the majority who support a clean game to help keep the game clean.
One possible restraint could be allowing the server admin to set the password level for access to the feature, and decide if all players, a few trusted players, or only the admin can use it.