I'm using KDE4 and xscreensavers. I've ATI drivers installed. I have this cool matrix screensaver and I set it to come on after 10 minutes and ask for password after 60 secs. When I moved the mouse around nothing happens or when I press characters on the keyboard. However when I press ESC, the screen flashes, the dialogue appears and then disappears. After I few presses, Xorg crashes.

Desktop Effects are enabled. Not sure how to fix this problem... I can disable the password but sometimes I'm at work and forget to lock the screen it would be nice if it did this on it's own. I haven't tried locking the screen manually to see issue occurs there too...

Perhaps you should lock the screen manually to see if the issue occurs there... You might always want to disable desktop effects and see if the problem persists.

Adam