The rules are unclear. You must

Ask the DM

According to the text of the totem druid's supernatural ability totem shape, the totem druid absolutely "gains the ability to change into" the totem shape "once per day." That ability can't be denied. Except it immediately can be denied by the sentence you noted that's part of the druid's supernatural ability wild shape: "The new [totem] form's Hit Dice can’t exceed the character’s druid level."

A ruling from the DM is required to make sense of this ability.

• Option 1: A totem druid can use his supernatural ability totem shape to assume the forms of creatures with Hit Dice greater than his level. Were he unable to, he's given up the standard, more versatile (yet acquired later) wild shape for, literally, depending on the choice, at low levels, nothing.
• Option 2: A totem druid cannot use his supernatural ability totem shape to assume the forms of creatures with Hit Dice greater than his level. Those are the rules, in place to prevent unbalancing the game by granting access to powerful forms too early.

The glass bear

Although it's very powerful to use totem shape (hence wild shape hence alternate form) to become, for example, a polar bear for an hour as a level 1 totem druid, the special ability alternate form doesn't, in itself, make that impossible. In fact, alternate form has these limits:

• The creature retains its hit points and save bonuses, although its save modifiers may change due to a change in ability scores.
• Except as described elsewhere, the creature retains all other game statistics of its original form, including (but not necessarily limited to) HD, hit points, skill ranks, feats, base attack bonus, and base save bonuses.

So even if a DM allows a level 1 totem druid to assume the form of, for example, a polar bear (MM 269), the totem druid will still probably only have 8 to 12 hp, and a lucky arrow or spear still drops him. Nonetheless, this remains a pretty serious combat buff.

The Conversation

The totem druid (Dragon #335 87) has two abilities relevant to the question. The first is totem animal:

At 1st level, a totem druid must choose one of the following animals to bind his spirit to: ape, bear, eagle, horse, shark, snake, tiger, or wolf.

The second is the supernatural ability totem shape:

Totem shape uses the same rules as wild shape, although a druid can only take the form of her totem animal. She gains the ability to change into this shape once per day at 1st level.

Starting at 6th level, the totem druid can choose to take the dire form of her totem animal once per day. The dire form is in addition to her normal form.

The specific supernatural ability totem shape overrules the more general rules of the typical druid's supernatural ability wild shape. Rather than reproducing wild shape below, I've reproduced wild shape below with the exceptions that are made because of the totem druid's totem shape.

At [1st] level, a [totem] druid gains the ability to turn herself into [her totem animal] and back again once per day. Her options for new forms include [the totem animal] with the animal type. This ability functions like the alternate form special ability, except as noted here. The effect lasts for 1 hour per druid level, or until she changes back. Changing form (to [totem] animal or back) is a standard action and doesn't provoke an attack of opportunity. Each time you use [totem] shape, you regain lost hit points as if you had rested for a night.

Any gear worn or carried by the druid melds into the new form and becomes nonfunctional. When the druid reverts to her true form, any objects previously melded into the new form reappear in the same location on her body that they previously occupied and are once again functional. Any new items worn in the assumed form fall off and land at the druid's feet.

The form chosen must be that of an [totem] animal the druid is familiar with.

A druid loses her ability to speak while in [totem] animal form because she is limited to the sounds that a normal, untrained animal can make, but she can communicate normally with other animals of the same general grouping as her new form. (The normal sound a wild parrot makes is a squawk, so changing to this form does not permit speech.)

A druid can use this ability more times per day at [3rd, 5th, 7th, 11th, 14th, 17th, and 20th] level, as noted on Table: [Totem] Druid. [Insert dire forms and planar forms totem shape advancement here.--it's unimportant to this answer.]

That's actually pretty clear by Dungeons and Dragons, 3rd Edition standards.

The DM must determine, however, if this text is part of the the supernatural ability totem shape:

The new [totem] form's Hit Dice can’t exceed the character’s druid level.

Which is the whole problem in a nutshell.

The Second Issue

A creature who can assume different forms can't deviate that far from the creature's printed entry unless special abilities tell him he can and how that's done. Most creatures who can assume alternate forms are stuck with printed creatures or variations on printed creatures. A generous DM may allow a character to advance the creature to such a degree that the creature's size changes if such advancement is still within the confines of his abilities. For example, a character who can assume the form of a hyena (MM 274) but is limited by his level in HD when doing so might be allowed, upon reaching level 4, to assume the form of a Large hyena (like a hyena that is advanced to 4 HD), but such a character could never become a Huge hyena nor a Small hyena as there's no way to make the printed hyena bigger than Large or smaller than Medium according to its creature entry; such a character would be stuck with either the Medium or the Large hyena form.

Like most other answers, I would say yes, two shapeshifts in a combat is legit; no, you did not make a mistake by allowing your player to wolf out and; no, you shouldn't try to claw back the ability.

One thing I would add to the previous answers is that this issue will almost certainly balance itself out fairly soon. Yes, a CR 1 creature in a level 2 party is huge. But level 2 ends quickly.

• At level 3, most classes get their archetype paths with cool powers and primary casters get level 2 spells. The wolf will be the same wolf it was before.

• At level 4, a CR 1 creature is considered a medium encounter for a single party member. Everyone will be pumping their primary stat or taking a feat. Wolves don't get much out of Wisdom, nor is there much overlap between the feats that help them and those that work for druids.

• At level 5, all classes see a major power spike. Cool abilities, level 3 spells, proficiency bonus goes up to +3. The party might also be finding minor, but interesting, magical items. While your Druid is kicking it lupine style, they won't get to enjoy any of that.

• By level 6, the Druid can finally upgrade to a CR 2 creature! Of course, at 450 XP, a CR 2 is less than a medium difficulty solo encounter for a character that level.

The dire wolf will remain a CR 1 creature while the world around it scales up. On top of that, if your player wants to jump straight into wolf form every encounter, then every encounter is going to play exactly the same for them, because a wolf only gets the one basic attack.

I'd say, let your player have their fun. Everyone should get a chance to feel like they've beaten the system once in a while. It doesn't seem to be worth the trouble of taking that away from them if the whole situation will simply resolve itself in time.

I'd honestly be more worried that a character with a d8 hit die has 28 hitpoints at level 2.