Start by digging out your multimeter and getting to the TCU under the right side of the dash. Verify that the TCU is getting +12volts on the yellow and red wires. If its not getting power, the tranny will give you 4th gear in (D) with no torque converter lockup and shift manually as you described. It might be as simple as a blown fuse.
If that checks out, then unplug the TCU and measure the resistance across the shift solenoids. Should be pins C14, C15, and C16 which my 88 FSM shows as the white with tan stripe, violet with tan stripe, and blue with tan stripe. The resistance should be 11-15 ohms.
The hard shifting might be needing to adjust the throttlebody-tranny cable, bad tranny mount, bad motor mount, sloppy u-joints, or a lot of slop in rear diff.
The reverse lights would be the classic NSS symptoms.
http://www.go.jeep-xj.info/HowtoNSSrebuild.htm
For grinding from the tranny area, I would check that the torque converter bolts are tight and the flexplate are not cracked. Check that the bellhousing bolts are all tight as well.