Andy,
I disagree with your blanket assertion that CHAP is a weak authentication method. It's strong if the password is a random string, or otherwise strong enough to resist searching attacks. Note that the iSCSI standard requires the use of distinct CHAP secrets for the two directions, if mutual authentication is used, so the reflection attack that classic CHAP suffers from does not apply in iSCSI and cannot work there.
Yes, the traffic is sent in the clear after that. Any protocol that doesn't encrypt the data phase is exposed to eavesdropping and connection hijacking. When you make security decisions about distributed systems, you have to consider the set of possible attacks and decide which ones you need to protect against, and which ones you choose to leave not covered.
CHAP protects against impersonation. It's not just for accidental misconnection, it also handles intentional misconnection, provided that the attacker is not able to perform connection hijacking.
Yes, some iSCSI implementations support IPsec. It remains to be seen whether anyone actually turns it on.
Data at rest encryption is a completely different service that covers a completely different set of attacks. If you mean volume encryption done at the initiator, it protects against eavesdropping but not against data modification; for that you need mechanisms that keep the wrong initiators from connecting, as CHAP does.
paul