Lennie's hallucination is a figurative expression of what Steinbeck himself stated Lennie represents; that is,"the inarticulate and powerful yearning of all men."
After Lennie drinks from the pool, he "embraced his knees and laid his chin down on his knees" like an unhappy and frightened child as he worries about what George will say to him. Then, he retreats into the past as his Aunt Clara appears in his mind and acts as his conscience.
Lennie hears his aunt tell him, "You do bad things." The childlike Lennie tries to excuse himself, "I tried and tried. I couldn' help it." Aunt Clara interrupts Lennie's excuses and points out to Lennie how good George has been to him. Lennie uses his usual argument of going away, but Clara tells him that he will never do that. After this, Aunt Clara disappears.
Then, a giant rabbit appears and castigates Lennie: "You ain't worth a greased jack-pin to ram you into hell." Further, the rabbit generates fear in Lennie, telling him that George is going to beat him.
"He won't," Lennie cried frantically. "He won't do nothing like that. I know George. Me an' him travels together."
But the rabbit insists that George is going to leave him. Lennie cries out in fear and calls George's name; having arrived there, George comes out of the brush and the rabbit disappears.
It becomes apparent from Lennie's hallucination that he actually recognizes right and wrong along with the failings of his character. But, he is too weak to control his behavior. He wants things to go well, but he cannot refrain from making mistakes. His frustration over his actions visualized in his imaginings is an expression of his yearning for things to be all right between himself and George as well as with the world he knows.