Wow, seeing where you're located, did you happen to buy a rig that was flooded out in Katrina?

I'd be worried about the tranny too. Usually the breathers are located in or near the shifters for both the T-case and tranny, so you probably have water in the tranny too. I would change that fluid immediately.

I'm not sure if the rust is something that is easily fixable. Oiling everything is definately worth a shot and changing the fluids several times. You might be able to just replace your current shifter with a wrecking yard part if that's the main problem.

If water got into the tranny/transfer case, then it probably got up into the cab area too. I'd take a peak around the wiring/computer to make sure things aren't too cooroded.