LUKE: [sees the people in the window] What the hell’s going on with them?
LORELAI: Oh, I don’t know.
LUKE: Crazy people. Whole town should be medicated and put in a rec room with ping pong tables and hand puppets.
Luke is describing what he thinks occurs in mental health institutions – psychotropic medication and mild social entertainment. The hand puppets may be (in his mind) to facilitate therapeutic dialogue.