Farewell, Marcel Ospel. The former UBS chairman did not seek re-election to the board of the Swiss bank at its annual general meeting yesterday. It was just as well since, after $37bn (£19bn) in subprime-related losses, he might not have survived.

His downfall was a long time coming. It has been 13 years since Swiss Bank Corporation acquired S.G. Warburg, the first move in his effort to create a top-tier global investment bank. After that came the 1997 acquisition of Dillon Read and Mr Ospel's canny reversal of SBC into the troubled UBS in 1998.

But the UBS fiasco is more than the story of a failed acquisition spree. It also embodies the rise and (current) fall of credit derivatives - the instruments that were intended to transform the humdrum but risky business of bank lending.

I can vouch for this because I remember going to see Mr Ospel in London after the Warburg deal closed in 1995, to find him fretting over the layout of its headquarters. The chief executive's office was on the seventh floor and he wanted to get closer to the traders two floors below.

After him, I met David Solo, the then 30-year-old head of fixed income who had previously worked at O'Connor Associates, a Chicago options trading firm that SBC had bought. Mr Solo was figuring out how not only to revamp Warburg but also to revolutionise lending.

He told me about the credit default swaps market, which had just started emerging in London. Mr Solo got out a piece of paper and drew a diagram of how loans might be priced like swaps and options and be traded by banks and investors. With hindsight, I wish I had kept that document.

Without knowing it, I was present at the creation of the new model UBS. Mr Ospel was cooking up a bank that could take on Goldman Sachs and others with the special ingredient of derivatives. An organisation that was not making enough money from domestic banking would take on the world with options.

Mr Solo, who later became chief risk officer of UBS and now runs the institutional asset management arm of the Swiss bank Julius Baer, was clearly on to something. There was no obvious reason banks had to make loans and hold them until maturity, taking the entire risk of borrowers defaulting.

Instead, he and others in the credit derivatives market reasoned that banks could originate and trade debt, using swaps and options to transform it into securities. Banks would take less credit risk and use up less of their precious capital while investors would get a new way to make money. Everyone would be happy.

They are not happy now. For these pioneers eventually created a market that grew so big and complex that Mr Ospel no longer had any grasp of the risks UBS was running. His traders - now in the US while he was in Switzerland - came to use the instruments more to game the system than to pass on risk to others.

I am indebted to UBS for making this fact plain in its fascinating report to shareholders, which it published under pressure this week in time for the annual general meeting. I recommend it to anyone wanting to find out how, over a 13-year course, beneficial financial innovation turned into deceptive financial alchemy.

By last year, it was scooping up mortgage securities and turning them into structured debt that could be sold to investors for a fee. Its traders realised they could make money by keeping the safest slice of these securities - the so-called super-senior tranches - and hedging them a bit to eliminate all discernible risk.

I say "discernible" because common sense would have told them that any security paying 2 percentage points more than Treasury bonds (as many such securities did) must be risky. But the bank's models treated hedged super-senior debt as entirely safe; it did not even register on its overall "value at risk" scale.

If UBS had treated these securities like loans, and examined all the subprime mortgages from which they were constructed, it would never have been so cavalier. It would have looked through the AAA rating on the bonds to the dodgy loans to subprime borrowers that lay beneath.

But it instead dealt with them as bonds that had been approved by credit ratings agencies and so required no fundamental scrutiny by loan officers. Its traders behaved as if the ratings shielded UBS from the reality that it had lent money to people who were not going to give it back.

This was the perverse outcome of the diagram that Mr Solo drew for me 13 years ago. Derivatives did not eliminate the credit risk; they simply made it invisible. When the subprime mortgage crisis struck, the losses spread to super-senior debt and UBS found itself holding $50bn of very troubled debt securities.

In a narrow sense, you could argue that Mr Ospel was not directly responsible for this debacle. Turmoil in the investment banking arm of UBS in 2005 as John Costas, its chief executive, moved to run a hedge fund led to traders being given too much leeway. Mr Ospel was not told about the exposure until too late.

In the broader scheme of things, however, Mr Ospel was its architect. He identified credit derivatives from day one as the thing that would allow UBS to catch up with Goldman Sachs. Treating loans as securities that could be diced, sliced and traded, rather than delicate and risky relationships with borrowers, was the basis of his strategy for the bank.

That is why the fact that UBS lost $37bn in less than a year is an indictment of Mr Ospel himself, not just of a bunch of deluded traders and ineffectual executives in the US. It took 13 years for the flaw to become painfully obvious, but it was there right from the start.

john.gapper@ft.com