Never mind - it would appear we were running on an old build; works in 2.0

It would appear that headers require you to leave a blank space after them, which doesn't appear to be in the Markdown spec:

Python 2.4.4 (#2, Oct 22 2008, 19:52:44) 
    [GCC 4.1.2 20061115 (prerelease) (Debian 4.1.1-21)] on linux2
    Type "help", "copyright", "credits" or "license" for more information.
>>> import markdown
>>> mystring = """# This is H1 #
... and some body text
... 
... ## This is H2
... and more body text
... 
... ### This is H3 #
... and the last bit of body text"""
>>> html = markdown.markdown(mystring)
>>> html
'\n\n<h1> This is H1 </h1>\n\n<h2> This is H2</h2>\n\n<h3> This is H3 </h3>\n\n'
>>> 

Using exactly the same code in the Dingus tool on the markdown website produces the expected result