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Kagrenac, in his effort to transcend the Dwemer race into immortality, caused the total nullification of his race from the mundus using the tools he created. If Nerevar and his Council; Sotha Sil, Vivec, Almalexia, were there for the battle at Red Mountain, when the Dwemer dissapeared, it is safe to assume that the massing forces of Nerevar and the Council(each great house and the Ashlanders) drove the Dwemer into a panic, causing either Kagrenac or someone else, say, the Dwemer council that admonished Kagrenac for creating and using them, to act rashly. I do not believe Kagrenac would've caused the genocide of his entire species from the mundus on purpose, I believe the 'nay-sayers' interfered just as he was about to invoke the 'tones' and caused him to 'miskey'. Instead of making them Gods he made them Ghosts.

I'd say it was Kagnerec's own doing that did the Dwemer in.
The Dwemer that we have seen (the ones in Vvardenfell, we have no clue what the Hammerfell dwarves were like) and their creation were all connected to Vvardenfell. This can be seen in one Mages Guild quest where it tells of a Dwemer creation non-functional when it's leaving Vvardenfell. But, they may also be tied to Morrowind in General. There were Centurions in the Dwemer Ruin under Plaza Brindisi Dorom, that worked. So, going under this, and considering Yagrum Bagarn's absence during the time the Dwemer disappeared, Kagnerec signaled to all other Dwemer Lords that he was about to activate the Tools.

This where it can branch off into two things, they all dying, or transcending. I believe it was the former. I say this because of the multitudes of ash found in the Dwemer Ruin previously mentioned. Since the place was left un-touched, it seems that Dwemer on Tamriel disintegrated into ash. (If they transcended, I believe there wouldn't be this ash. You also have Dwemer Spectres, if they did transcend, why are they there?)

That's my two cents.