Sounds like the thrust arm bushings are shot - a typical problem for e34's. Most people replace the arms and use 750i bushings in place of the e34 bushings. They're beefier and should last longer. BMA sells Lemforder arms with the 750i bushings already pressed in. Instructions to do it yourself are here http://www.bmwe34.net/E34main/Maintenance/Suspension/Upper_arm.htm.
Good luck.
Curt.