Is it legal and is it appropriate to display religious items in faculty offices in the United States?
There's a big difference between inconspicuously displaying religiously-themed materials in one's office and effectively proselytizing, as the retired faculty in your example apparently did. The former is I think entirely reasonable, as it's a personal display that does not put any burden on a visitor or guest to the office. Putting religious materials in their inboxes is unwanted, and is inappropriate for a faculty member to do (particularly given the power imbalance involved).

I don't think I've ever received (or heard of) a legal notice that one is not allowed to display religious imagery in a personal office. Is it a good idea? Again, I think it's a question of degree. There's nothing wrong with displaying a small cross or Star of David or moon and crescent in one's office. Having a large and ostentatious display, though, would probably put students ill at ease. Similarly, having those materials where you actually meet with students (say, at a conference table in the office) is more "aggressive" than just having it on a bookshelf.