Sounds like a blown fuse to the TCU (electronic Transmission Control Unit).
On the older jeeps the TCU and fuse is just under the passenger side lower dash cover. I think the TCU was still there in 96. It is a small galvanized steel box with a bulkhead wiring harness conection. The fuse is an inline fuse (unless they moved it to PDC box under the hood by 96?), about 12 inches from the TCU box.
The AW4 auto transmission only shifts into 2nd in the 1-2 possition at or above about 4500 rpm! Or if you are doing about 35- 40 MPH (don't quote me on that number) and you drop into 1-2 from 3rd, it will go into 2nd instead of first.
Sounds like the AW4 is OK, and just needs the TCU power restored, or maybe the TCU is disconnected? Several good therads here, just search for "transmission control unit" in advanced search for more details.