The way I see it, Israel went (maybe) irreversibly down the wrong road with the assassination of Rabin.
If you will recall, the assassin was a radical settler. However, there was no backlash against the settler movement because of this. The assassin and his co conspirators went to prison, but when Netanyahu came to power, he rewarded the settler movement extravagantly; giving them more money, and expanding settlements immensely. The assassin is considered to be a hero among the settlers, and some of his accomplices that have been released have received hero's welcomes.
In short, because the settlers profited so handsomely by murdering Israel's elected Prime Minister, there's no reason to think they wouldn't do it again.
When assassination becomes an acceptable (and the people of Israel did accept it, see below) part of the political dialogue, one can expect a lessening of quality of people in politics, and the leadership showing less courage to propose changes. And, indeed, this has clearly happened.
Why was there no backlash against the settlers? Why did the people of Israel not object strenuously to the murder of their leader? I think that more than anything, Israelis fear civil war. The theory that built Israel was that Jews had such a distinct identity, that all they had to do was get in one place and they'd be a nation. In reality, Jewish groups from far flung corners of the world had little in common, and Israel today is a country divided by factionalism, and only the illusion of solidarity holds the country together. When the settlers demonstrated that they were willing to murder their fellow Jews for the sake of their political beliefs, the others had to make a decision;go along with it and preserve the illusion, or go down the road of Civil War.
This choice has led to the dominance of the right wing in Israel's politics, with Netanyahu being the dominant post-Rabin figure. He has built his career on trying to build an Israeli identity based on fear of the Other (Palestinians, Iranians, Europeans, even Americans, as it suits his purposes) and by strengthening the dominance of the Orthodox faction(s). Part of this has included deliberately antagonizing outside forces, even ones that would normally be friendly to Israel, all to strengthen the siege mentality that lies at the core of his political agenda.
It rather puts me to mind of Israel's situation nearly 2000 years ago: riven by factionalism, one faction, the Zealots, decided that in order to unite Israel behind them, they should start a war. Unfortunately, in their racist fanaticism, they failed to realize that Rome was not the sort of country you fight a wag-the-dog sort of war against.
Israel's course of action is clear: They need to do what they should have done after Rabin was murdered: Condemn his murderers and treat them like the terrorists that they are. The settlers are the authors of all of Israel's internal woes.
Israel united is strong enough to resist any outside threat. The Palestinians are no threat to them, the idea that they are is Netanyahu's propaganda.
Israel must do what it can to strengthen the PA, rather than undermine it, which has been Netanyahu's life's work. Hamas is a threat only because Israel has done so much to undermine its only competitors. Anyone who thinks Netanyahu wants peace is a fool; he has built his career on beligerance. When the times are peaceful, people have nothing to do but to talk about how corrupt he is. Read Israel's papers. It reminds me of what Mao used to say about Matsu and Quemoy islands: "They are wonderful, I'm never going to take them over. Whenever I want an international incident, all I have to do is shell them."
In summary: Get rid of netanyahu, suppress the settler faction, and strengthen the PA. All of Israel's external problems grow out of their internal divisions. As Kissinger said forty years ago: "Israel has no foreign policy, it only has a domestic policy." This is still true today.