First of all, if your light is coming on, you definitely have something going on. These systems are not known for faulty readings. Even if you do a full check and find nothing, something usually gets worse until you can "see" it later. This is only verified by the fact you had trouble shifting the T-case. You should be able to shift on the fly between 4hi and 2hi all the way up to 55 mph. The same is true for A4WD (Autotrac). However, you have to slow down below 3 mph and put the tranny in Neutral before going to 4lo. Wait for the little light in the 4lo button to stop blinking, then put it back in gear. I assume you did this. I'm not trying to treat you like an idiot, just kinda expounding for the benefit of those other fellas who were kinda unsure about this engineering marvel known as Autotrac (don't even get me started on some of the fancy new crap I've heard GM researching for newer trucks....better get one now[sad]).
So, you have a warning that says, hey you might potentially have a problem with your 4 wheel drive. I know, that's like saying you can get kinda pregnant[img]/wwwthreads_images/icons/tongue.gif[/img]. Seriously, though, the OBD II systems on these new trucks like ours is pretty complicated these days. The Powertrain Control Module will give you that warning simply when the right parameters are met. This could mean your truck really is about to s#!t the bed, or it could mean you have a sensing problem, which is what we want (cheaper). In ALL cases, the PCM has a decent safety buffer, and gives you the warning plenty early.
Basically, if you can get access to a decent diagnostic scan tool, you'll narrow this puppy down in a hurry. The make aftermarket ones either generic or manufacturer specific. I hear either can be pretty pricey. Maybe a buddy has one? I have a list in my repair manual of the typical generic codes, and, honestly, I only see one that relates to the transfer case. Most likely need a GM specific scanner to get some good indication of what's up. Plus, the PCM in these trucks has what's called a freeze frame feature. Basically, it senses something outside parameters, lights up your little light, but then begins to record readings from any and all other sensors related to that particular system. The dealer can plug into your diagnostic port and download all that and get a chronological "picture" of what happened where...kinda like watching a little movie. Even if they make you pay for accessing the codes, hopefully it'll be one of the following things below, which you can replace on your own and be out the cost of the codes and the new part.
From what you described, it's probably one of the following things that's malfunctioning:
1) Transfer case control switch (your silly buttons)
2) transfer case shift motor
3) transfer case speed sensors
4) transfer case control module
The T-case control module is a little electronic brain of it's own. It receives the signal from your control switch telling it to engage the transfer case shift motor. The motor rotates the sector shaft where you want it (the gear you called for). It then has a motor lock on it which engages to keep it from popping out of 4wd. A transfer case encoder is a sensor also mounted to the shift motor that relays the position of the sector shaft back to the module. Once it's in the right gear, the module (transmission control module...not the same one) then sends a signal to engage the front axle. Voila...4 wheel drive. Simple isn't it?? The only difference is when you put it in Autotrac, the shift motor lock is placed in an adaptive mode by the module so it can be applied and released as the module needs it. The transfer case speed sensors can detect wheel slippage by measuring the speed of both output shafts of the T-case. They send a signal to the control module, and it commands 4hi to engage and lock. Once the speeds of both shafts become equal again (your front and rear axles are all at the same speed...no slipping), the module re-instates 2hi. And back and forth you go.
So, the light coming on could mean anything. You never said anything about grinding or leaks or jumping in and out of 4x4, so I doubt it's driveline (good news...T-cases are expensive and so are differentials). So, it's merely an engagement problem at this point. It could be as simple as your buttons themselves are bad...to a bad control module, or shift motor, or motor lock or any of those. Even though you didn't try Autotrac (or did you??), it could be those speed sensors too. It's a sensor, which means the PCM probably monitors it, which means it could have illuminated your light. The only reason that doesn't make sense is you had problems engaging in the first place, which those sensors don't handle for 4hi or 4lo.
Holy cow, that was a lot. I got carried away, but I sure hope you get it fixed man.
<font color=green>'99 Silverado 2500HD ext. cab/SWB, 6.0L, manual, 4.10's etc. etc.- not even close! no mods yet!</font color=green>