Here's what I do, and I don't know if it's exactly what you are talking about.

I make sure that my players understand that what I tell them, is what their character perceives. It is not guaranteed to be accurate.

One example, I had a player who decided to keep a dangerous magic item that they knew nothing about (it looked like bad news, though). It was cursed, and started making the character paranoid. Rather than simply say, "Your character is affected by a powerful curse and is paranoid," which would spoil the fun, I just started describing every random passerby as looking "shifty" or telling them that they seem to be paying too much attention to their new magic item (and probably are thinking of trying to steal it). The player was freaking out, and was actually genuinely paranoid that someone was going to steal the item, and hid it deep in his bags all wrapped up. Once he was good and unnerved, I told him that he saw the glint of a dagger in a crowd, and felt someone trying to steal his bag. He attacked the thief, and killed him. Except it wasn't someone trying to steal his bag, it was just an a random passerby who accidentally bumped into him. Everyone started freaking out when I described to them how he spun around and murdered some random guy in the streets, and he starting raving about how he'd been following him, and he had a knife (he didn't), and how everyone was trying to steal his item. It was hilarious, and he sounded exactly like a crazy person made paranoid by an evil artifact. The players took talked to him about it, and got the curse removed, but damn it was fun screwing with him.

Thing is, that player was a little pissed at first, and started yelling at me about lying to him (I didn't, I just colored my descriptions of things a bit). He calmed down, and thought about it, and he actually thought it was pretty cool even if it was at his expense. He never trusted me as a GM again though. The player (not just that character) was genuinely paranoid all the time that what he was "seeing" in my games wasn't real, and I think it spoiled his fun a bit.

Moral of the story: be careful when playing with player trust. It's hard to earn in the first place, and if you betray it, they may not give it back.

However, I would totally do it again, because it was freaking awesome, and I'm too evil to resist.