Reading fairy tales that are labeled as fairy tales, as long as the specific content is unobjectionable, seems OK. What distresses me is to see Midrashim and Aggadot taught / read to young children who cannot yet understand the point of the Midrash – which is usually implied or a matter of hashkafah. Midrashim are not cute stories which are even better the less logical or realistic they are.
When midrashim that are “non-realistic” in the daily world are taught to small children as literal happenings, this can create serious problems when the child grows older. He/she feels a demand to believe literally something which is meant on a symbolic level. The result is that the child starts believing the midrash is “just a bunch of fairy tales” which they don’t dare contradict in front of the rebbe/parent. This attitude can then spread to the rest of Torah observance and hashkafah. I’ve seen children (and some grown-ups) struggling with this very issue.
There waw a letter to the old Jewish Observer asking about the Harry Potter books, and the reply was that yes, it’s dangerous, because our children could transfer the idea of fantastic fiction to our midrashim!
Mirashim are not entertainment. They should not be read to children as such. The definitive book on midrashim is “The Juggler and the King” by R’ Aharon Feldman, shlilta, Rosh Yeshiva of Ner Israel. He expands on the dictum of the GRA that aggadata are not to be taken literally. Chazal didn’t waste their time telling cute stories. They were leaving us a hashkafic legacy for the ages.