NEW YORK (Bloomberg) - As the sun streamed through the glass ceiling of London's 40-story "Gherkin" tower in May 2007, Thomas Jasper raised his champagne glass.

Almost 25 years after the former Salomon Brothers Inc. banker transformed the derivatives market into a trillion-dollar industry, his latest venture, Primus Guaranty Ltd., was poised to make unprecedented profits.

"To wider spreads," Mr. Jasper, Primus's CEO, said as he hoisted his glass to the crowd in the bar, predicting his firm could increase prices for the credit-default swaps it sold to banks protecting corporate debt as investors became nervous over growing losses on sub-prime mortgages.

Primus shares have fallen 82 percent since that evening. After the failure of Bear Stearns Cos. in March 2008, the world's largest banks refused to buy protection from the Bermuda-based firm, which used leverage of more than 30 times its available capital to guarantee $24.3 billion of debt.

The collapse of institutions from Lehman Brothers Holdings Inc. to Icelandic banks has left Jasper fighting to conserve cash and defending the industry he helped create. Regulators have blamed bets made with credit-default swaps for contributing to $1.3 trillion of losses and writedowns at the world's largest financial companies.

The credit swaps market is not the cause of the meltdown, Mr. Jasper, 60, said in an interview in his Midtown Manhattan office, on the 23rd floor of the building that also houses the derivative-industry association he co-founded.

"The issues that you had, that we're all living with right now, are issues of bad underwriting and probably a regulatory framework that couldn't keep track of where the risk was," he said.

Primus is now at the mercy of a market that Jasper laid the foundation for in the mid-1980s by turning interest-rate swap transactions that once took days to negotiate into a standard contract.

Debt traders used these as the template for credit-default swaps, where insurance companies, hedge funds and banks used leverage to guarantee at least $2.5 trillion in debt, according to data from the Depository Trust & Clearing Corp. in New York, which runs a central registry that captures most trading.

"Tom was the Henry Ford of derivatives," said Richard Grand-Jean, 66, former managing director of international capital markets at Salomon and now New York-based principal of alternative-investment firm Hall Capital Partners LLC. "He brought mass production and uniform standards to the market."

Derivatives that American International Group Inc. failed to understand prompted the US government to commit $182.5 billion in loans and capital infusions, said Christopher Whalen, a managing director at Torrance, California-based bank research firm Institutional Risk Analytics.

Richard Fuld, the former CEO of Lehman, in October 6 congressional testimony blamed his firm's September collapse on "destabilising factors" including the soaring cost of credit swaps on the New York-based investment bank.

The development of credit derivatives from interest-rate and currency swaps was "a horrible mistake" that "exponentially increased systemic risk", said Mr. Whalen.

Without regulation of these over-the-counter markets, excess was inevitable, said Michael Greenberger, a former director of trading and markets at the Commodity Futures Trading Commission and now a professor at University of Maryland School of Law in Baltimore.

"If you take the cop off the beat in a neighborhood, all kinds of malpractices will be committed," Mr. Greenberger said. "These markets are opaque, and people wanting to heighten their returns will lever up. The adverse of levering up is heightening your losses. It's the fallacy of human nature that you go into these things overly optimistic."

Salomon's managers asked Mr. Jasper to develop derivatives because he had the "methodical mind that a good commercial banker should have", Mr. Grand-Jean said.

The Wisconsin native worked for five years in loan syndication at Bankers Trust Co. before joining New York-based Salomon in 1981. With a University of Texas master's degree in business administration, he entered the finance world after a stint in Washington during the 1970s.

Encouraged by his lobbyist father, Claude, the former head of the Wisconsin Republican Party, Jasper joined the Price Commission set up by President Richard Nixon to battle inflation.

"I was the guy who told McDonald's they couldn't have a one-cent increase on their hamburger price because it was inflationary," he said. At night he drank beer on his father's houseboat on the Potomac River with members of Nixon's administration, including Melvin Laird, the defense secretary.

Jasper got involved in derivatives in 1982, a year after Salomon created the first swap that enabled the World Bank to obtain Swiss and German currencies by exchanging cash flows with Armonk, New York-based International Business Machines Corp.

Such transactions took days to negotiate, said John Brim, who was a vice president in corporate finance at Salomon and hired Mr. Jasper to syndicate loans.

Salomon saw an opportunity to capitalise if it could create an active market for swaps, said Mr. Brim, 63, who, with Jasper, completed the firm's first interest-rate swap. Mr. Jasper then led an effort to transfer the product to the trading operations.

"Instead of a cottage industry, with bilateral trades, they did it off the trading floor and that led to a huge business," said Mr. Brim, managing member of Hill Street Capital LLC in New York.

Increasing volumes required a standard contract. In 1985, with representatives from 10 banks at The Breakers resort in Palm Beach, Florida, Mr. Jasper helped set the terms. The so-called swaps code that emerged in the months after that meeting laid the groundwork for a master agreement, allowing swaps in virtually any asset class to be traded. Interest-rate and currency derivatives gave way to instruments used to hedge or speculate on commodities, equities and credit.

Mr. Jasper also founded and became the first co-chairman of the industry group now known as the International Swaps and Derivatives Association.

Success with swaps led to stints building Salomon's Asian banking business. Mr. Jasper rose to be the firm's global treasurer after its merger with Travelers Group. By the time Mr. Jasper left the bank in 1998, the market had grown to $51 trillion for interest rates and currencies, ISDA data show.

As Mr. Jasper vacationed in Hawaii the following year, the rapidly growing credit-swaps market dragged him back.

Jay Shidler, a real-estate investor and venture capitalist based in Honolulu, drove to Mr. Jasper's hotel with an idea. During the 1990s, banks devised credit swaps as a way to protect against defaults on corporate loans by paying debt investors fees to take on the risk. Mr. Shidler wanted to tap into those fees and sought a CEO to build the company.

Mr. Jasper needed to raise capital and persuade Moody's Investors Service and Standard & Poor's to bless Primus with their top AAA counterparty ratings.

The process took three years. By March 2002, Primus had raised $270 million of financing, including $155 million in equity from insurance companies XL Capital Ltd.; Radian Group Inc.; Aegon USA; and PCG Corporate Partners LLC, a private-equity fund backed by the California Public Employees Retirement System. A Radian subsidiary also provided $115 million of insurance, according to a Primus statement.

To secure the top rating, Primus could guarantee only debt of investment-grade companies, according to Moody's. The highest credit grade was crucial to win the confidence of the more than 30 financial firms that agreed to trade with Primus, the company has said in regulatory filings.

Unlike hedge funds and other credit-derivative sellers, Primus didn't need to post collateral against trades if the perceived risk of defaults rose. The ranking also lowered financing costs, boosting the company's profit on the contracts, the filings say.

"It's an exceedingly hard organization to structure," said Mr. Shidler, 63. "Tom's genius is the ability to hit a bullet with a bullet."

Two years later, Erin Callan, an investment banker at Lehman, who became chief financial officer before the firm failed, persuaded Mr. Jasper to take the company public. In September 2004, Primus sold 10.3 million shares at $13.50 each.

By March 2008, the company had sold $24.3 billion of swaps on mostly corporate debt, more than 30 times the $774 million of cash and liquid assets that was held by Primus Financial Products LLC, the firm's credit-swaps unit. Investment banks, insurers and hedge funds, including Massachusetts Mutual Life Insurance Co., AXA Investment Managers and Deutsche Bank AG, created similar entities known as credit-derivative product companies.

For six years, Primus never had to pay its counterparties because of a company default. Then Mr. Jasper's model started to unravel.

Following the downfall of Bear Stearns, banks refused to buy credit swaps from anyone that did not post collateral. That shut off Primus's ability to profit from the wider spreads Mr. Jasper had craved that May night in London at 30 St. Mary Axe, called the Gherkin because of its resemblance to a pickled cucumber.

The company's dependence on keeping AAA ratings by following strict guidelines set by Moody's and S&P forced Primus to bet heavily on highly ranked financial firms that became the epicentre of the banking crisis, Mr. Jasper said.

With the government seizure of mortgage-finance companies Fannie Mae and Freddie Mac, and the crumbling of Lehman, Iceland's banks and Washington Mutual Inc., the company had to pay almost $146 million to settle credit swaps within three months. That included $73.1 million to make good on $80 million in guarantees on Lehman debt, or more than 91 cents for every dollar of protection sold.

"We felt comfortable selling protection on Lehman," Mr. Jasper said. "Primus, like many investors, relied on their public statements of their financial well-being and ability to manage through the crisis. We were clearly wrong."

By October, Primus's financial products unit lost its AAA rating from Moody's. S&P cut the company in February to a level that bars it from doing new business.

While bank failures have slowed since the US government committed to spend or guarantee $12.8 trillion to prop up the financial system, companies continue to default. Primus said this month it has to settle $10 million of swaps safeguarding the bonds of Idearc Inc., the Dallas-based Yellow Pages directories publisher that filed for bankruptcy protection. Idearc bonds are trading at less than two cents on the dollar.

As of December, the company guaranteed $1.7 billion of debt rated below investment grade by Moody's, up from $552,000 at the end of June 2007, according to a Primus investor presentation. Almost 10 percent of Primus's portfolio of swaps tied to companies or countries is rated junk by the service, the data show. Moody's predicts the amount of defaults for junk-rated companies will rise to 14.8 percent by year-end.

Primus will weather the default cycle and continue to collect fees from existing contracts, said Tom Brown, CEO of New York-based Second Curve Capital LLC, which was the second- largest Primus shareholder as of February. The company will receive $280 million in premiums from contracts that, on average, mature during the next three years, according to S&P.

"While they're going to end up with more credit events and a higher severity than I thought two years ago, in the eye of the hurricane last quarter they had just one credit event out of 15," Mr. Brown said.

Jasper, Primus's largest individual shareholder, according to regulatory filings, is also optimistic the firm can rebuild.

He plans to develop a new business selling credit-swap protection by posting collateral against its trades. Banks will continue to need institutions to take on the risk of corporate debt, he said.

"As the one who founded this industry, of course I'm frustrated," Mr. Jasper said of his role in creating Primus. "When things change you can cry over spilt milk, but that's not particularly productive, and you've just got to move on."