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@sbt, excellent! Happens for me too: trying to allocate a 1MB block fails after running ugly_hack() once. That fits the symptoms: lots of smaller, varying-sized allocations, followed by free()s, followed by a "largish" allocation. Don't know _exactly_ which largish allocation is failing. Could be the next non-trivial dict resize, or, because I'm running under Python 3, a largish Unicode string allocation.
Unfortunately, using the current default-branch Python in a debug build, the original test case doesn't misbehave, so I can't be more specific. That could be because, in a debug build, Python does more of the memory management itself. Or at least it used to - everything got more complicated in my absence ;-)
Anyway, since "the problem" has been produced with a simple pure C program, I think we need to close this as "wont fix".