I suspect this is something to do with
The first paragraph seems to be about
In the second paragraph, your rival is deciding
The third paragraph is about
I would be flabbergasted if it weren't to do with crossword clues. "Too short" could mean either that the answer seems to have to be too short given how much is going on in the clue, or that the clue seems too short given the length of answer needed.
I don't agree about the second paragraph. I think the first and third paragraphs are different attacks on the same clue.
I don't think I agree with your analysis of the third paragraph either. I think the word "say" is going to be significant (it can indicate either "for example" or "sounds-like"), and I suspect something like "O say" where the thing that looks like a letter O turns out to signify zero/nothing/nil/... .
In particular, I think the zero is the rival's description of something in the clue rather than in the answer.
Incidentally, I suspect that the "feeling of self-esteem" is part of the clue rather than the rival commenting on his mental state.
Actually, if I'm right about an O being involved it could equally well be in the answer, the clue perhaps containing "... to say nothing ..." (which might fit with the stuff about silence earlier?)
@Gareth The main thing that convinced me about the second paragraph was that the clues described in the first and third seem to be rather different: in the third paragraph, at least one letter seems to be known already, and knowing one letter would make a 2-3 letter clue almost trivial. And yet your rival seems to be quite stumped in the first paragraph, looking at words as different as CD, gag, and shh.
I agree re "feeling of self-esteem", especially since the OP forgot that sentence originally and then thought it was worth editing into the question.
I don't think any letters are known already; I think we aren't hearing all the rival's thoughts (it's a noisy connection...) and he has particular words or bits of words in mind. I'm not sure whether the CD is being considered as an alternative to shh, gag, etc.; I think I assumed not.
You definitely have something here. A few non-spoiler clarifications: We get to hear mostly all the thoughts except for the answer. And I should not expect someone to cook up an entire crossword from three paragraphs of bare-bones thought process...I ain't so cruel. :)
@GarethMcCaughan I think that part of the clue is "say nothing" and the solution might be EGO. "It's not telling -- it's giving an example" refers to the word "say" (as in "rand al'thor, say" for "puzzler"). The solution for that is e.g.. Then "nothing" refers to "zero", which is represented as O. So then e.g. + O = EGO, which fits with "That gives me a feeling of self-esteem."
Maybe the cryptic clue is simply, "I say nothing. (3)". That would explain the "silence", "gag", and "Shh" ("say nothing"), and the "I, three? ...could it be one?" (find a 3-letter word for "I" that means "oneself"). But that doesn't explain "a CD maybe?" or all the stuff about the "D"...
Hm. Maybe something indicated that the answer was one of the three parts of the psyche?
"Ego" definitely seems like the right answer (with definition "I"), and it appears that at the beginning the rival thought the answer was "Id". So they tried to look for the letter D and couldn't find it.
"I say nothing" giving EGO sounds awfully convincing and makes me much more sympathetic to Rand's proposal that we're dealing with more than one clear here.
His answer (in whose comments this discussion originated) proposed multiple clues. (Multiple clues for multiple lights in the crossword, not a more-than-two-part clue for one light.)