TOD is not related to engine stumbling, knocking surging. Since you say elimination of TOD eliminated drivability problems, you're probably right in your assumption of engine OK but TOD caput.
here's 2 cents:
1. Hard to tell what the problem is from here. Are you getting any TOD error codes? Let me rephrase. What TOD error codes are you getting? See http://vehicross.info/forums/showthr...&highlight=tod Look for Deermagnet post.
You might want to do a search on "mode switch" - that might explain the erratic TOD indicator lights and maybe more.
2. Actually, since you have a LSD, it IS 2WD (as opposed to 1WD with an open diff) And all you're screwing up is some damn good traction. You cut the blue wire so the TOD clutch is not engaging but input and both output shafts are still turning so transfer case is being lubed. Uhhh.... wait a minute.... that last thought just caused another synapse to sputter... TOD howling you say? Does the howl change volume in time with the flashing lights and is it more of a groaning (lower pitch) or is it a more constant, higher pitched, bearing whine that varies pitch with speed? When's the last time you changed the ATF in it? Is the level proper? What happens when you put it in 4L?
You should consider fixing that ABS as well. Might come in handy some day!