Hey guys!
Well, I'm back and I've decided to finally start what Eloth recommended that I do. I've been talking with LA Sentry about creating these dream scenes to replace the old messages that you would receive during the main quest of Morrowind. This is the level that I designed for the first dream. This is the story of the first disturbing dream according to the UESP:
"I had a disturbing dream. I can only recall one part. A tall figure with a golden mask led me among the dead as through a wedding celebration. I heard many voices, but no lips moved. I strained to breathe, but my chest didn't move. The tall figure spoke with each figure as he passed among them, laughing and joking, as if they were alive, but they made no reply. I tried to cry out, but without breath, my tongue fluttered in vain."
So far, this is what I have for the first dream. I hope to add a quest and scripting to it so that it will add immersion and allow the player to experience the dream within the game. The other dreams may be just movies. Any constructive criticism is greatly appreciated before I go about adding scripts and everything else.
Here is the link to the video: http://www.youtube.com/watch?v=6XX-MacySJM

Interesting reading everyone
Interesting reading everyone's ideas. Such a cool concept. I personally believe that obscurantist's youtube mockup is really good with the blurred vision, lack of control over the player with just the ability to move the camera.
I think it could be cool if the dream started completely black with ominous music/sounds and then a sinister picture of dagoth ur's mask and/or of things to come flashes/fades in front of the screen before it faded away so that the player finds himself walking down the hall asking what in the nine is this? implementation maybe similar to the images that flash in front of you in fallout 3 in a particular vault so it would happen while you're in the cutscene. it would help to separate the player falling asleep from normal gameplay and signal crazy dream stuff. just my two cents. Even if 2d is a no go, I think fade in from a few seconds of black and creepy sounds would be awesome.
perhaps for the last dream start out with the sound of a beating heart in pitch black and have it fade into Dagoth talking while walking around the heart of Lorkahn under red mountain?