I think the reason he brought up mental illness is that he believes just the experience would cause emotional trauma even if you know it's fake, so it sounded like I was saying 'You should be able to overcome PTSD through willpower' or something.
I would argue that, knowing it was fake, it would not cause the same emotional trauma. I suppose maybe if they did something to block out your knowledge that it's fake during the simulation. But it's not the same as getting emotionally involved in a holodeck program. When you enter a holodeck the goal is to become emotionally involved. You are putting yourself in a state where you are emotionally receptive to something you know not to be real, in this simulation you would not do this.
I suppose if there was physical pain involved you could easily develop PTSD from the experience, but again, I'd argue that'd be more difficult if you were able to carry the knowledge that none of it would have any lasting real life consequences. For O'Brien a big part of what made is so traumatizing was the belief that he was seriously in danger of starving to death and the belief he would never see his family again. I absolutely believe it would have cushioned the blow and changed his attitude toward his cell mate if he knew no real time was passing, he would definitely see his family again in the same state he left them, and he was in no danger of death.
Disregarding the particulars of the episode and the technobabbly explanation that might come if the writers were pushed, false memories are still memories. In spite of the fact there was no real event, they are nonetheless in memory, and years of therapy are required to recover from them, if not a lifetime.