The player used the spell in exactly the way it was intended - to blind large crowds.
It's worth noting that this likely
wasn't the intent. The spell is about revealing invisible or concealed things. The blinding is a side effect, one that was probably put in as a nod to "realism" and that whoever wrote the spell clearly underestimated.
Do you really think that overpowered abilities are intended to be so? No one's defending Glitterdust as a well-written spell. Out of several hundred (or thousand, going beyond core) there are going to be some spells that don't work as intended. You seem remarkably forgiving of mistakes in your game of choice (of which there are many, by any measure), is it so strange to you that DMs and players are willing to accept and deal with the rates of error in games with better editing but higher (and riskier) aspirations?
And the player gets screwed over because the DM doesn't approve of his carefully constructed encounter being trashed by the caster. How do you explain this?
No, not because his encounter is trashed. Because the spell itself is inappropriate. The encounter may or may not be trashed, and that isn't really the point. Sometimes encounters are trashed for good reasons and you let it play out and move on. Other times it exposes a flaw in the system, and you have to decide how to deal with the flaw.
The player hasn't done anything wrong
...and isn't being treated as if he has. He's not getting punished (though you seem to be implying that), his actions are being adjudicated by the person whose job description it is to adjudicate them.
Playing Mother May I is not an experience I ever want to repeat.
Your loss, I suspect, disregarding that ridiculous term. But there are plenty of games out there for you regardless.
I mean, Fly and Invisibility are both pretty bog standard spells and not exactly eating up a whole lot of resources. Arcane Eye, AFAIC, is a basic spell that every wizard should be bringing out.
But why would he if he has someone else to do similar functions? Assuming the wizard has a regular party of companions, it makes sense for him to learn spells that expand upon or complement the other characters' abilities. Trying to replace them is not a logical goal, regardless of whether it is possible or not. It makes the party as a whole less powerful because the wizard is wasting resources that could be used elsewhere.
BTW Arcane Eye is one of those spells I don't know if I've ever seen anyone choose. I couldn't even remember what level it was, and I'm a 3e encyclopedia.