I actually think the solution you outlined would be ideal. I am all in favor of it. I just don't think it will happen. When i was a teen i would repeat something similar to what you just listed every-time the Israeli-Palestinian discussion would come. Israel must act, but over time (now in my 30's) i have come to conclusion that solution would never work.
I think the Palestinian leadership need to accept that they are not in a place of power for negotiations. They have to accept they won't get east Jerusalem. They also need to accept that Israel won't negotiate with Hamas. Abbas needs to distance himself from Hamas and perhaps even go as far as dissolving the Unity government and just deal directly with Israel to solve the West Bank. I am against the settlements, but I have come to accept that they are there. The Palestinians cannot afford to continue on their current path, there won't be much left of them or their land. Their Arab neighbors don't want or care for them, most of the international community don't really care and with the US governments unwavering support of the Israel, the Palestinian leadership need to make the hard choice of giving up a lot of what they have wanted and accept any comprise they can get - though it is going to be really difficult with the current Israeli government. Perhaps they can force Israel's hand by having Obama mediate the negotiations, another Camp David if you will.
I am pro-Israeli right to have a state, and pro-Palestinian right to have a state. I am neither Israeli, Palestinian, Jew or Muslim. Though I am definitely anti-Hamas, i have seen what Islamic militance has done to families - I am of Iranian ethnicity and many in my family have been killed at the hands of Islamic militants for nothing more than just not agreeing to their ideology and trying to leave a peaceful life. You just have to look at the family of the 4 boys who died on beach from IDF shelling. One of the members of the family stated that many members of her family had been killed by Hamas. Here the quote:
Anyhow, I am more than happy to debate any of the points above.