Arab grievances have to do primarly with the refugee issue and the nature of Israel as a Jewish state (one where Pals cannot feel at home). Here, I think an answer may lie in a two-tiered approach. In the short term, after a Pal state is established along the lines of Ray's plan, reparation packages (perhaps even "symbolic" ones) should be provided to the families of both Palestinian and Jewish refugees. In the longer term (and here's the real kicker), I think Israel and Palestine should agree to become a single state in 100 years with one key stipulation: There is no longer a need for a Jewish safe haven. In the new state, Palestinians and Israelis would have no state religion, and be allowed to live where they wish. This plan would provide a much needed long-term opportunity to cool down, establish real relations, and perhaps come up with an even better solution.
from the article: Peace Plan: Trading settler Israelis for refugee Palestinians