Z. Writing an entire language and ecosystem just for a game is insane.
These are not binary choices: there is a very smooth continuum between these two, and is one of the major advantages of Lisp. Naughty Dog just took too many steps from A towards Z. Each step probably seemed reasonable at the time...
Don't think so. It was actually a series of games and critics generally like the game engine aspects. Naugthy Dog developed for new platforms and their games were written to show off the capabilities of the platforms. Since there were no off-the-shelf game development systems like that - where one could develop inside a running game on prototype hardware - they developed their own. At that time there was a lot more Lisp education and they had their computer science education from MIT.
Looks like the GOAL/GOOL runtimes and dev environments worked very well, created well received games and they sold a lot of them. Naughty Dog used Allegro Common Lisp on the development environment side and their own Scheme-based runtime on the game hardware.
Later when they were bought by Sony, they switched to C++ to be able to share code inside Sony - which then seemed to be problematic and they returned to Scheme for some stuff:
https://www.slideshare.net/naughty_dog/statebased-scripting-...
The situation today is different and the technology stack is different.
Unreal Engine was very successful with a custom scripting language up until UE4, too. And Naughty Dog hardly seems to have suffered from their decision to build a Lisp-based system -- apparently they're still using Racket to script their (wildly successful) games.
Really, it's only quite recently that the off-the-shelf tooling like UE4 or Unity has gotten sophisticated and powerful enough that people can make complex games without having to build a little software ecosystem around them.
Neverwinter Nights: https://en.wikipedia.org/wiki/NWScript
Morrowind: http://en.uesp.net/morrow/editor/mw_scripting.shtml
And I suspect countless others. (These two games exposed their developer tools to the customers so they could extend the game.)
Surely you must have heard of the term "Domain Specific Language" by now? Many are one-offs per project, heavily including games as well.