The event got its start at MidAmeriCon in 1976 when Gardner Dozois and George R. R. Martin retreated to the bar to drown their sorrows. In the course of the drowning, they decided that there should be a party for Hugo loses and Martin's room was volunteered for a Monday night party which they stocked with scrounged drinkables. Dozois was doorman, letting only true losers in: When Joe Haldeman stopped by, they informed him that since he wasn't a loser (Joe had won for The Forever War), he wasn't welcome and was booed and pelted with peanuts unless he told a good story about why he was really a loser! (They set him in w=anyway, of course.)
It became a Tradition when they ran it again the following year at Suncon and then at Iguanacon. Eventually, other people took over running the party, until Nolacon Two in 1988 when the people running it decided they couldn't, Noreascon 3, the upcoming 1989 Worldcon was asked to run it and agreed. The following year, Noreascon 3 offered ConFiction (the 1990 Worldcon the chance to run it, they agreed, and it became a Tradition.
Over the years, the party has taken on more formal trappings and now usually includes food, drinks, a chance to ogle the full voting results, and a Hugo Losers Gift. It's also gotten a lot more stuffy, even with attempts to call it a "Hugo Nominees Party" or suchlike. Some Worldcons elect to give Hugo Nominee gifts instead of Hugo Losers gifts and Hugo winners are often now allowed into the party after a set amount of time (frequently coincidental with the end of mass photography of the winners).