Our bathroom wall is rotting out any suggestions???

If its that soggy then you should remove it all before the mold starts to grow and get worse,if it didnt already!
go to your local home center and pick up cement board and do the entire surround in it! then tile it.!

after doing demo make a disicision on the tub or shower pan condition,now would be the best and cheapest time to replace it, same with the shower diverter!