Watching this video should remind us of the kind of people we're dealing with in Tehran. The British sailor is obviously under duress and forced to tell lies as a hostage. Displaying captive soldiers in this way is repulsive to all decent international norms and it has been approved by the central power-brokers in Tehran. This isn't a maneuver we can even try and blame on Ahmadinejad.
The salient question, however, is what this means. The hope is that it means that the gradual international coalition against Iran has had an impact. It may be a sign of desperation for the regime to try and use a bargaining chip in this way. The fear is that it reveals that the regime in Tehran cannot be in any way dealt with, and that a confrontation on a wider and larger scale is only a matter of time. Britain doesn't have the power. The U.S. does. But even then, military action to topple this regime, after the disaster in Iraq, is not a serious option. It would initiate something close to a world war with unforeseeable consequences. Probably the best response, then, is what Blair is doing: insisting on the truth, demanding unconditional return of the hostages, and using the incident to further isolate Iran at the UN. I'm afraid I see no other viable option.