Hammerfell wasn't the province that waved the White Flag. And The Thalmor did not 'give back' cities. The Leigon kicked them out of Cyrodiil, or to be technical, killed them. Lord Naarifin and his army? All dead. Lady Aranayela's Army? All dead. The Aldmeri Armies were annihilated at Red Ring.
Only Lord Naarifin's forces at the Imperial City were annihilated. The Thalmor still presumably held the southern cities of both Hammerfell and Cyrodiil. Heck, it took the Redguards five years to drive the remaining Thalmor out. In some ways letting Hammerfell go when they rejected peace may not have been so terrible: the Thalmor failed to gain any territory, yet the Empire, which seems to now be the objective of the Thalmor, was able to begin recovering sooner.
Something that's also bugging me is that of the stuff that the Empire has done, they either had little other choice or they'd be condemned either way. They couldn't help Morrowind because there was a succession crisis at the time. If they punished those that sacked Orsinium they'd be condemned for killing their own people. If they tried to retake Black Marsh, they'd be derided for wasting lives on an otherwise unimportant and inhospitable province, assuming they succeeded at all. If they retook Morrowind later, the Dunmer would probably oppose it, and again the Empire would be condemned for it. If they sided with the Redguards, they may be able to drive the Thalmor out of Hammerfell and Cyrodiil, but it'd also mean that they'd have a longer way to go before they could recover enough to actually take the fight to them.
Being more proactive against the Aldmeri Dominion seemed like a good idea in hindsight, but being peaceful and unaggressive doesn't make one a terrible ruler. And few actually saw the threat of the Dominion before the Great War.