The diplomacy system is not bugged. The diplomacy system works as designed (as I understand). The fact that the system doesn't work to your liking or my liking doesn't mean it doesn't work.
Yes, it is. Let's be simple. Share a border = ennemies to death. Doesn't share a border = want my kings head on a silver plater ? May sound like a feature to you, but it sounds like a bug to me. It can be exploited in many ways to get ceasefires and money : for example holding Antioche isn't worth it, just give it to the pope, get ceasefire with the neighbours (a few thousands florins very quickly made and of course top relations with the pope even if you fooled him) and get it the next turn when the city revolt. Do it again and again. Even better, someone hold Cyprus or Rhodes ? Not only you can take it but they will pay you for a ceasefire next turn since an island doesn't share border (makes Cyprus 10 times more valuable than Acre or Antioche). Still think its a feature ? well ever wondered what happens to a faction lonely on his island ? well, nothing : they sit there forever, not going to crusade or declaring war to anyone, try it : No borders, no wars.
So, no, sorry but I don't believe there are "objectives behind the game" that nobody saw until today. There's just an agressive AI, relationships constantly decaying based on difficulty level and a 100x border-war-factor you can work around to exploit.