Maybe clamp off fluid lines to see if pedal improves? EDIT: Well, obviously not now you have changed the m/c, but you sneakily retro-edited your message
My project 164 feels like the brake pads are made of wood. I had all four discs machined, but the shop left quite a coarse pattern on the disc, which doesn't seem to be wearing off (maybe they forgot these discs are harder than modern types, I believe). I also suspect mine would be worse than yours because I have a cross-rod running across the bodyshell - pedal on the right, master cylinder on the left. That must surely introduce some flex.
All the time I've worked on brakes, I've had spongy problems.
I suspect two things: coatings on backs of pads (either copper grease, or silicone goo - the latter being very effective at stopping squeals but seeming to make the spongy problem worse)
and the other thing being pads not bedded-in - can take a long time to bed in pads these days, I find.
My 156 has SUPER-feeling brakes. Neither of the two things apply.
The calipers are more robust-looking and the discs are larger (and, all four discs are new - the originals had worn out, I think modern discs are softer than the old. Pads are new and un-coated). The car itself is, of course, smaller and lighter, so it stands to reason that the brakes would be awesome. A friend lives on a country road. I had the car wound up a bit (three figures in your money) and suddenly realised I was about to pass his driveway. Well, I stood on the pedal hard, and slowed from 170 to 40 in what seemed like about 20 metres. Of course the iPhone on the seat went flying, my sunglasses came off, and even the carpet mats moved. The ABS and EBD, not to mention stability program as well, as I turned into the gravel driveway at 40km/h, was wonderful.
I think some of these improvements were achieved in the series-II 164 ('94-) (which probably has the same discs and calipers as my 156 anyway) and I think Jason has written in length about it.
Most of the time I drive economically and therefore hardly use brakes anyway. That could be one of the reasons I have so many problems with brakes.