The New York Times reports that since we've had such a catastrophic run with home mortgages, it's time to watch the collapse of commercial ones. The same names surface when it comes to the collapse of our financial system -- in the case of commercial mortgages Deutsche Bank (NYSE: DB) ($25.1 billion), Morgan Stanley (NYSE: MS) ($22.1 billion), Lehman Brothers (NYSE: LEH) ($40 billion in commercial mortgages and property), and Citigroup, Inc. (NYSE: C) ($19.1 billion) are among the biggest holders. They are also big names in Auction Rate Securities (ARS).

Why do people think that commercial real estate could be tanking? Here are four reasons:

• Declining property prices. The Times reports that the Moody's/REAL Commercial Property Price Index has dropped 12% since its peak last October.
• Commercial mortgage write-downs. According to the Times, Morgan Stanley reported commercial mortgage write-downs of $400 million and Wachovia (NYSE: WB) said it would take at least $1 billion worth of such write-downs.
• Potential Riverton default. The Times reports that Riverton, a 1,230 unit Harlem development, was premised on the idea that developers could convert "lower-priced rentals to apartments priced closer to the higher market average." But the Times reports that Monday Fitch "issued a negative watch on part of the Riverton Apartments trust" since the developers had not made much progress -- threatening commercial mortgages that Citi and Deutsche Bank hold.

MAJOR PAPERS:

• The Wall Street Journal reported that New York state's attorney general, Andrew Cuomo, has launched an investigation into auction-rate securities and is seeking information from some of Wall Street's biggest institutions including UBS AG (NYSE: UBS), Citigroup Incorporated (NYSE: C) and Merrill Lynch & Co Inc (NYSE: MER), a person familiar with the matter said.
• According to the Financial Times, Deutsche Bank AG (NYSE: DB) and other investment banks are working on plans to develop a clearing house for the credit derivatives markets. In an attempt to reduce counterparty risk, the banks are trying to develop a system that would only allow institutions with strong capital bases and credible trading histories to clear trades in the credit default swap markets with a central counterparty.

OTHER PAPERS:

• The news that The Royal Bank of Scotland Group Plc (NYSE: RBS) is planning a rights issue of between GBP5B and GBP12B received mixed reviews from British analysts and investors, the Telegraph reported. The analysts expect the bank to cut its dividend.

WEB SITES:

• DigiTimes reported that Nvidia Corporation (NASDAQ: NVDA) is planning to launch the GeForce 9600 GSO GPU in May to compete with Advanced Micro Devices' (NYSE: AMD) Radeon HD 3830, according to sources at graphics card makers.

Auction-rate securities were supposed to be cash equivalents. Individuals and companies could move in and out of them in a day. The financial instruments have existed since 1985. In an auction, any imbalance in securities bought and sold were picked up by banks and brokerages and sold at the next event. These auctions went on as often as several times a week.

The problem with the market is that when banks started to run low on money, they pulled their commitments to run the auctions, the market fell apart, and the securities do not trade. Because they are illiquid, their values are falling.

Many companies put cash into auction-rate paper to get a slightly higher yield than with government securities. The firms even put the money on their balance sheet as cash equivalents. Now that practice is haunting them.

Several technology firms are stuck with these investments. According to The Wall Street Journal, Monster (NASDAQ: MNST) had $357 million of this paper at the end of last year. Palm (NASDAQ: PALM) had almost $75 million at the end of February. The companies are going to have to write-down some of the value of this capital which will affect their earnings.

The problem cannot really be blamed on the companies. The market for he paper is over 20-years-old and has functioned like clockwork until recently. It does raise the specter of lawsuits against the banks and brokerages who made the market. They positioned these securities as cash and then pulled the plug on the auctions.

It is one more headache for financial companies in trouble, but in this case, they probably deserve it.

Douglas A. McIntyre is an editor at 247wallst.com.

The Wall Street Journal [subscription required] reports that we need to learn about another acronym thanks to Wall Street's financial engineers whose fragile financial instruments keep blowing up. Today's explosion is in variable-rate demand notes (VRDN) -- which let issuers borrow for long periods -- but at short-term interest rates. Like auction-rate securities (ARSs), interest payments adjust on a weekly or even daily basis. The difference is that securities firms sell VRDNs at whatever interest rate meets the market's demand.

This is a huge market -- $500 billion, or 52% bigger than the $330 billion ARS market. I've been asked what I thought the next shoe to drop would be after the ARS blowup. And I'm happy to report that I said I had no idea. I had never heard of VRDNs before this morning. But the market for VRDNs is freezing up -- just like the ARS market.

Specifically, some VRDN auctions failed -- hitting some municipalities with sharply higher interest because dealers of the debt are having trouble selling it. Last week, rates on $300 million of California's variable-rate demand notes rose to 8.25% from 2% the previous week. As with the ARS market, this freeze up will lead to more unpleasant surprises for holders of VRDNs -- like the one I posted on yesterday in which a journalist who thought his ARS investment was as liquid as a money market fund discovered his funds were frozen.

The worst part for the investing public is that we have no way of knowing where the next explosion will take place. It looks like some financial terrorists are winning.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.