This is remarkably similar to defeatable traction-control; people who care enough to figure out what that button does will push it and have fun. People who don't won't and they'll be safe.
If we're building endpoint networks to prohibit local traffic, we are forcing a terrible architecture with terrible long-term privacy and security implications. Because of this, we will have a future where the NSA (and vendors, and advertisers, and the Chinese PLA, and ...) will literally know when you flush your toilet. In the future every interaction you have with every device in your house will be broadcast to third parties across multiple national boundaries and clouds.
... because we had to protect Windows XP machines from rare, marginal threat profiles. (Has anyone actually seen malware spread this way in the past 10 years in the wild?)
The potential criminal and totalitarian applications of a cloud-powered IoT world are incredible. Look into "nudge theory" for a starting point, and then consider things like:
http://www.theatlantic.com/technology/archive/2014/02/when-y...
http://www.ibmbigdatahub.com/blog/power-behavioral-fingerpri...
The decision of how to architect our communications infrastructure today and whether to, for example, permit local traffic could in the future determine whether or not we evolve into a borg-like totalitarian collective or a cooperative society of sovereign individuals. Communications infrastructure affects... well... how we communicate... which in turn affects every single aspect of human society and culture over very long spans of time.
It's a special case of a larger phenomenon called path dependence. Small choices that you make today based on what seem like rational reasons today can have huge differences in the long term outcome of things in the distant future. While the future isn't fully knowable, sometimes conceptual reasoning from first principles can tell us what the likely outcome of a particular path might be.
> Has anyone actually seen malware spread this way in the past 10 years in the wild
Yup, had several IR cases (trending up) where this was determined to be the initial vector. Related: stop making this argument. Nothing is seen in the wild until it is (go back a few years and realize this argument was made about cryptowall-style malware).
I think you should re-read the end of my first paragraph; isolation should have an off switch. Give people the option and let them choose. Sorry if that's bad for your business model.
Network node security should not be delegated to the network. Not only would this necessitate forgoing very useful features that networks enable, you won't improve node security. Devices that are vulnerable by merely sharing a network with other nodes tend to have other more sever security lapses.
I agree that a button is simple way to switch between modes, but it will also make point-to-point the default. People don't change defaults, and companies will eventually cease to implement network capability as a result.
I'm all for better network security, but not at the expense of discarding the network itself.