Man, a mountain is being made about a molehill again, with morals/ethics once again being dragged in and judgement passed.
The OP bought the Kindle in good faith. The price it was offered at is the sort of price one would offer if one bought an item, found out that one didn't like it, and wanted to sell it to get at least as close to the original price as realistic. I'd be more suspicious of a new Kindle being offered for $50.
The OP contacted Amazon. Unless I missed a post in this thread, the rep didn't tell him/her to return the blacklisted Kindle to them. So the Kindle is the OP's to do with has he/she wishes. The OP now has a Kindle that can't use the Whispernet and is merely another ereader and can use it as such. Use a program that will convert books to the Kindle format and at least get some use from it.
We don't know if the Craigslist seller was a thief who stole it from the original purchaser, or the original purchaser who reported it as stolen in order to get another Kindle. Either way, it's immaterial. The OP isn't going to get the money back, the seller isn't going to take it back (if the seller can even be located again), the original purchaser has gotten a new Kindle, and Amazon has probably been reimbursed the cost of the Kindle from the shipper's insurance. To go through the rigamarole of trying to get all that reversed will cost them more than the $120 the OP shelled out.
As others have stated, contact Craigslist and give them the particulars of the sale and the person involved. That way you will have acted as a conscientious member of the site. You already contacted Amazon. You've covered the bases. There's no point in contacting the police; the money amount is just too low for them to realistically do anything about it, not to mention the jurisdictional questions and the like. Keep the Kindle and let the experience be a lesson learned about buying from third-party sites.