Two of my favorite books from Morrowind are http://www.imperial-library.info/content/five-songs-king-wulfharth and http://www.imperial-library.info/content/poison-song. Alas while browsing the Imperial Library today, I noticed that the Five Songs was listed under the jokes, songs, poems and plays; and The Poison Song was listed under the fiction section.

Does that mean that Wulfharth and Dagoth Tython never existed? or Does it mean that the events in those books were over exaggerated?

Wulfharth existed. He has a plaque commemorating his reign in Windhelm. It's listed under "Songs" because it's technically a song.

Poison Song is a work of fiction. I doubt any such person as Dagoth Tython ever existed.