Negative equity is indeed a serious problem for the individuals. In an earlier property crash the nearby new-build estate of Bradley Stoke became known as Sadly Broke.
But that isn't the same as the "wealth" of a country.
Property prices are "paper money" that is unavailable until you downsize towards the end of your life. Too high property prices mean that the cash cannot be invested in something that will pay dividends down the line. Remember one of the consequences of "tulip mania": the Dutch were less able to compete with the UK in expanding trade with the far east - and that allowed the British to gain many parts of their empire.
It's not quite the same, but has the same effect. Countries simply cannot afford to reduce house prices in relevant ways. If debt isn't covered by some form of collateral, things start going awry. Unless you reduce the value over longer periods than a typical mortgage will run, of course, but that's unlikely to consistently happen. It's easy money for a government. If the collateral deficiency becomes too large, a country's credit rating will go down, with interest going up and causing a negative spiral. Even if the money isn't even actually spent, a nation will go bankrupt if house prices are affected too much. Conversely, having more housing and higher house prices is a great way of increasing value without actually needing to do a lot of actual work.
That it's money you cannot spend until you cash out isn't entirely true either. Looking at the trend over the past 100 years or more, house prices in most developed nations have only gone up, with one exception spanning only a few years. As soon as your house has surplus value, it's possible to convert the difference into cash without actually selling your home. You just have to make sure the value of your house doesn't drop, as your leeway will be gone.
Finally, rather than ever growing housing prices stifling growth, they actually seem to foster it. Most house owners in developed nations earn more by rising property values than they could ever earn with any kind of job, financial wizards in the City excluded. The longer you wait buying in, the further you will fall behind. Obviously, that's not something that can continue forever, but for now it's pretty much impossible to ignore.