The quest for graphical realism in games has been running against a diminishing-returns-wall for quite a while now (see hardware raytracing - all that effort for slightly better reflections and shadows, yay?), what we need most right now is more risk-taking in gameplay by big budget games.
Maybe if there's a fundamental leap in AI. It's still undecided if larger datasets and larger models will make these problems go away.
You only need to apply generative AI to game assets that do not do well with the traditional triangle rasterization approach. Static objects are already at practically photorealistic level in Unreal Engine 5. You just need to apply enhancement techniques to things like faces. Using the traditionally rendered face as a prior for the generation would prevent hallucinations.
There's a reason why such "build your own story" games like Dwarf Fortress are fairly niche.