OK. I took my query in a different direction and did a search on bypass hoses and it led me to a bunch of responses I hadn't run across before dating back to about 2002. I think I am smarter and can hook the 261 engine coolant bypass correctly now but certainly this isn't the last word on this subject.

I am posting what I found so that if someone else does the search for this same subject (its bound to happen)they can get a summary here of what I believe to be accurate information.

There is a certain amount of other information out there including that the extra holes in the thermostat and water pump housings are for a second heater on things like a school bus. I didn't find that credible in light of the other explanations below.

What I do find credible is that the 261 went into really hard working bigger trucks generally and they need extra protection against heavy duty use and the coolant bypass is one of those protections. (Darn I hope I'm right).

I was looking in particular for information on how the original setup looked and while I never found a picture of the setup I did find a witness to an original setup: 4onthefloor had a previous post to another inquiry where he states:
"Well, I got my engine (261)out of an unmolested 62 burb, and the burb had the smaller fittings for the heater from the waterpump and the lower part of the thermostat housing, AND THERE WAS A BYPASS HOSE THAT WENT FROM THE UPPER PART OF THE HOUSING (THE PART THAT HAS THE BYPASS HOLES IN THE STAT) BACK TO THE WATER PUMP... (my capitalization for emphasis)

Someone else posted this information re. the 261
"...The 261 Stat has a nice bypass setup hooked to it so there can be circulation between the head and the block through the water pump without the heater hose being open."

Finally this nugget of information:
..."This is from an article in the tech tips section of inliners international: 'In its pure big truck form the 261 had a larger thermostat housing holding a double acting thermostat: This is designed to circulate water through the block and head before the thermostat opens to allow hot water into the radiator. Thus, no internal steam hot spots during warm ups, expecially in winter. This is particularly important with the very cold coolant. Vital engine spots can become very hot before the total coolant becomes hot enough to open a normal thermostat on the front of the block.' You can tell its a thermo housing from a 261 if it has two holes drilled for the smaller hose fittings in addition to the large one that feeds from the radiator. It is slightly larger than the 235 housing and it contains a hard-to-find by-pass thermostat."

I'm a much happier guy and will hook up my 261 coolant bypass as 4onthefloor indicates it should be.(top part of bypass hose to top fitting in thermostat housing and lower part of bypass hose to either fitting on water pump).

Thanks to all who contributed.
Jerry