An extended case study of an analytic treatment examines the difficulty of identity formation for Sephardic Jews in Israel, on the background of negative stereotypization of this group by the Ashkenazi Elites during the first decades of Israel's existence. Zionism was based on the idea that a New Jew needed to be created, as the Old Diaspora Jew was seen as weak, dejected, and self deprecating. The hypothesis is advanced that the Old Jew remains a split-off part of Israeli identity, which is experienced as threatening, and that psychic wounds often found in Sephardic Jews in Israel reflect the projection of disavowed aspects of the Old Jew by Ashkenazim onto Sephardim. The case example shows how this wider social reality influences transference-countertransference interactions in analytic treatment. The patient's transference love and the therapist's complex countertransference reaction are analyzed not only as individual issues but as reflecting Israeli history and its present social and political reality.