My father's CJ-7 was set up like this when he first bought it. Apparently the guy who owned it previously, snapped an axle or something and opted not to fix it. Instead, he put the Jeep in four wheel drive and drove it like that.

It wasn't very good for the front tires. However, after driving the Jeep over 1000 miles, there was no damage that my father could find to the transfer case or otherwise. He simply replaced the axle (let me tell you, once he tore it apart, it was quite apparent that this was a huge safety issue) and everything worked fine. Well, until he dropped second gear.