OK, here's the follow-up:

We bought a new Dorman brake master cylinder. Not the highest quality part available, but it's what we could get same day. Installed it and bled the master cylinder on the car. With the new master on, it still gave us the Brake Failure light. Reading through the factory manual, it seems that repairing a leak and bleeding the brakes should reset the light. Ours didn't.

So, we decided we would take the Octopus apart. It's not a particularly complicated part. And upon opening it up, it was easy to see that ours was hung up. So, we cleaned everything up, cleaned up the bore and sliders and seals. We annealed the copper crush washers on each end and re-assembled. Interestingly there really wasn't much wear on the parts at 285,000 miles. I guess if the brakes are functioning properly, the octopus doesn't really do much.

Obviously, we bled the system (again) using the the Volvo factory manual recommended procedure and a pressure bleeder. I think the pedal pumping while pressure bleeding is really effective. Got lots of bubbles out.

So, the answer to our problem was both the brake master and the octopus. Both required attention. There is about 3/4" of travel before the pedal gets very firm. Problem solved.