Red Mountain erupted because people lost their love for Vivec, which held Lie Rock above Vivec City. Some of the Dunmer sorcerers anticipated this coming and built a machine that runs off souls to keep the moon up regardless of Vivec's enchantment fading. Some how the machine failed, due to internal disputes over the morality of soul harvesting among the two chief engineers of the machine, and the moon crashed onto the city. Hard. The two engineers were cast into Oblivion and the rest of Vvardenfell went bye bye pretty quick. Then the volcano erupted.
The reason the moon was able to do so much damage is it was magically frozen in time and space. It maintained its original momentum from when Sheogorath chucked it at Mundus. It was going really, really fast just like an asteroid would have been.
Some corrections:
The Rock that was floating above Vivec was the Ministry of Truth, which was held up by Vivec. But Vivec disappeared, and in his absence, Vuhon creates an ingenium in order to keep it stable. he uses dying souls as base, and then uses a small number of living souls as fuel for the ingenium. But he uses the soul of the Wife of Sul, who fights Vuhon, and the ministry of Truth becomes unstable, and crashes into Vvardenfell. Then Sul and Vuhon is cast into Oblivion.
(Then they get out, Vuhon creates another ingenium, for Umbriel, then the same thing happens again, Sul fights him and Umbriel Disappears.)