2 slices of bread wrapped in paper towel microwave set on defrost set 35 seconds caught fire

Microwaves work by friction. They blast water molecules in the food so they move fast, just like rubbing your hands together makes them hot. Some types of microwave in defrost mode actually apply FULL POWER for a short period of time so to make the product warm to the touch. This heat then penetrates down to the core of the food, ensuring full defrost. In your case the heat was sufficient enough to heat the dry paper towel to set it on fire.
Bread is better defrosted on the low power setting as sliced bread is very thin. Items should only be defrosted on the defrost setting that are thick and need to be completely defrosted on the inside. Remember microwaves only penetrate the surface of food, making that hot. Thermal conduction does the rest.
You should never use paper towels in a microwave unless the instructions for doing the food say so. You wouldn't put a paper towel in a gas or electric oven, so don't put them in a microwave.