sounds like maybe the locking clutch pads were malfunctioning (pretty sure they used clutch packs vs. gear type). the hopping is never fun.
I think the issue was with the auto locking hubs; when it malfunctioned it would lock the front hubs together and in turn the transfer case would lock the front and rear diffs together, causing the wheel hop. This defect probably contributed to the death of the original transfer case, now that I think about it.