Two things I don't understand:
Why did the neutrals at the top of the panel burn? They don't seem to be related to the disconnect in any way, so I'm thinking they're the result of a separate incident.
Since the disco wires themselves aren't burned, I'd guess that the panel main CB tripped quickly, helped by the very short wire run to the disco. If it hadn't, this could have been a nasty fire.
But what caused the disco bar to short to the screw terminals in the first place? I suspect that the insulating parts between the bar and the knives failed and/or disintegrated due to the water damage, allowing the bar to rotate in deeper and hit the screws. If the handle has an overcenter "snap" spring, all this may actually have happened completely unattended.
I'd have to say that any disconnect that can fail in this way, regardless of damage, is of an unforgivably bad design.
Oh yeah, and the guy who screwed those wires to the buses is an idiot.