I think that the Dreamcast would have been technically capable of handling the graphics of Model 3 games; the Model 3 can run at a consistent 2 million polygons per second, sources suggest the Dreamcast can manage a consistent 3 million per second. However, the two architectures are very different, making porting games in their full glory quite difficult. Given enough time to perfect it and wipe out any bugs, perfect Model 3 ports are theoretically possible, just very difficult, and Sega clearly decided it was not a good use of their resources.
Mind you, regardless of whether good Model 3 ports were released or not, I still don't think the Dreamcast would have done too much better. It would have still been sandwiched between the PS1 and PS2 (the PS2 has much stronger graphics), and the bad reputation Sega had thanks to the failure of the Saturn (and the Sega CD add-ons) would have been awfully hard to overcome. A few extra good games, in my opinion, wouldn't have made the Dreamcast last any longer.
In any case, I'm still gutted that Daytona 2 never got ported.
