I'd most definately go with air in your system. Just make sure you bleed the brakes in the correct sequence, or you'll end up with the same problem. Also, how are your drum brakes? If your shoes are out of adjustment, you could also lose braking power. The pedal might feel spongy if more fluid is going to the brake cylinders to move out the shoes. Happened to me. Spongy pedal and crappy braking, no matter how many times it was bled (or by whom) and when I re-adjusted the back, everything was fine.