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Okay well you have to do a full restore. Turn your itouch completely off. With it off, hold down the circle button and plug in the USB cable connected to your computer. The itouch will power on and you will see the apple, but keep holding in the circle button. After 15-30 seconds, you will see another (different) cable/itunes screen on the iphone. iTunes should then recognize that the itouch is in recovery mode and you can then do a restore. You should be good from there.
Remember, turn off the itouch. Then while its off hold down the circle button and plug it in. Keep holding down the button until the recovery screen comes up. Good luck!!
If your itouch reads "disabled connect to itunes" and shows the "locked" icon and your itunes will not even recognize the device and itunes says your itouch is locked and enter password, Here is what you do to restore your itouch: (you will lose all itouch contents but it is worth it as almost all say it is broken and worthless)
1. Turn off your itouch or ipod. Do not have charger / usb connected to ipod or itouch.
2. With device off, connect the charger end of the cable to the itouch / ipod but do not plug the usb into the computer.
3. Open Itunes
3. While holding down the menu button (and I mean keep holding it down), plug the usb into the computer.
4. Wait to see the new wonderful graphic on your device and computer screen that shows that your ipod / itouch is recognized.
Your itouch will start immediately restoring itself and you are ready to fill it up with wonderful images, photos and videos again!
So happy to share this tip. It saved me money and time.
"Hold down the power and home keys down for about 10 seconds each while
plugged into itunes. When the screen goes black, release the power
button but keep holding the home key until itunes says. We have
detected an itouch in recovery mode.