So tonight I went back to it. I removed the flywheel and inspected the mating surfaces, then applied some moly grease and re-installed it. This is where the lesson in physics happened. The torque specification for the flywheel bolt is 150ft-lbs. I weight about 165lbs at the moment. The torque wrench is about 2 feet long. The distance from the center of the crank to the engine mounting bolts is less than 12 inches. The full repercussions of these facts were not immediately obvious to me. After attempting a few different positions I figured out that I could stand on the end of the engine mounting bolt and pull up on the torque wrench to attain the required torque specification.
Unfortunately even taking these steps did not solve the problem. The runout was still 0.012. I removed the flywheel again and rigged the dial indicator so that it rode on the flywheel mating surface at the end of the crank. Unfortunately this showed some lateral movement as I turned the crank. This is where the lesson in economics starts. I'm going to have to strip the engine down again and inspect the crank more closely. I may need to send it out for rebuilding which is not cheap and would blow the rest of my rebuilding budget. :(
So that I can end this post on a happy note: my brother gave me a most excellent christmas present. I unwrapped it and found a painted canvas. I had to stare at it for several seconds before I figured out what I was seeing. It looked very familiar and yet....
Click the image to see a high res scan as well as the answer to where the image comes from. It makes an excellent desktop picture.