Sorry, I don't know much about postgis at all. I assume you meant to have THEN 1 in your update statement as well.
I notice b.fid=l.fid and NOT b.fid=l.fid in the two clauses. How about separate update statements?
UPDATE linesegments l set edited = 1 WHERE l.gid IN (SELECT li.gid FROM linesegments li, buffered as b WHERE ST_Contains(b.the_geom, li.the_geom) AND (l.edited = 0 OR l.edited = null) AND NOT b.fid=l.fid); UPDATE linesegments l set edited = 2 WHERE l.gid IN (SELECT li.gid FROM linesegments li, buffered as b WHERE ST_Contains(b.the_geom, li.the_geom) AND (l.edited = 0 OR l.edited = null) AND b.fid=l.fid);
Something like this (and similar for b.fid=l.fid) should be equivalent to the above as best I can figure. It might be more performant, but I don't know the internals well enough to say for sure.
UPDATE linesegments l set edited = 1 FROM buffered as b WHERE l.gid = l.gid and ST_Contains(b.the_geom, li.the_geom) AND (l.edited = 0 OR l.edited = null) AND NOT b.fid=l.fid;