Saw someone the other day making a quite long object, and trying to hold it vertical with a stabilizer; one wasn't enough, but there were clearly some... interesting forces at work along the stack. I'm not entirely sure that torque and shear are being computed!
There may be some simplifications with parsing a composite (glued) object as a multiple-DoF flexible object, with some eventual force limits (which might not be any particular force so much as displacement of the flex joint itself). That might actually be a rather helpful simulation, if it means basically applying a fabric model to the structure (which they probably already have in the engine), just with different angles and rigidity for the bones.
I think they generally dialed up the damping factors quite high, which gives behavior that is rather unrealistic if you know what you're looking at, but is quite suitable for easy gameplay. The forces available from the Ultrahand are tremendous, but it seems you have some difficulty actually slapping or crushing yourself -- despite velocity and crushing being sources of damage.
Clearly, your example shows one perhaps poorly considered counter-example of this. Perhaps the propagation of the water waves contributes to that -- the interaction of two systems, which might well be separate systems glued together by physics. That could easily happen, and likely they can't dial up the water damping without making waves look obviously flat. I don't think I've seen assemblies of similar size/count misbehave on land or in the air; but perhaps one merely needs enough phase shift along a much larger assembly to find the "dry" edge case.
Even truly unstoppable forces are handled impressively well -- there's a "golf" shrine somewhere with a constrained pendulum (single axis of rotation; or was it two (both swing axes, no axial rotation)?), and a "gate" that rises from the floor -- to prevent you from taking a swing as the mechanism resets the "golf club" you're supposed to set up. Well, it can happen that the "club" pitches forward above the gate, and you can hit the switch, triggering the gate. Which dutifully penetrates into the "club" you've attached to the pendulum, breaking the "glue", but also..... not even exploding the "club", it just, kind of... smooshes out of the way and falls gently to the side.
They must've worked very hard to avoid the "super physics deform" (SPD) effect, characteristic of the Source engine (Havok physics) for example. Most physics systems, really, when driven with conflicting constraints, or just a little too much energy, tend to have divergent results, so they did a good job avoiding that, at least in most cases it seems.
Meanwhile, speedrunners have discovered item duplication and wall clipping mechanics (which are variously being patched out already), partly through abuses of the menu sorting and item crafting mechanics. Nothing, it seems, so critical yet as to be able to summon arbitrary items or effects (compare: Ocarina of Time's "[Reverse] Bottle Adventure" inventory manipulation glitches), let alone memory manipulation or code execution (ACE).
Tim