* Auction clearance rates drop sharply from 2017
* Auctions a bellwether of property demand in Australia
* Chinese capital controls, foreign buyer taxes have hurt demand
* Strict bank lending rules, Royal Commission, are other factors
* One economist sees 30 pct chance of recession, financial crisis
By Swati Pandey and Wayne Cole
SYDNEY, July 18 (Reuters) - It's a winter weekend in Sydney's bustling northern suburb of Chatswood and a three-bedroom family house sporting an endless garden is up for auction. It's priced to sell at A$1.88 million ($1.4 million) but no buyers bite and the sale is abandoned.
On the same day, in the heart of the harbour-hugging city a two-bedroom apartment with panoramic views fails to sell as no bidders turn up.
Auctions are a bellwether of demand in property-obsessed Australia, where attending sales is almost a national pastime. It is therefore telling that only just over half were successful the weekend last month a Reuters reporter visited some of Sydney’s auctions, compared to more than two-thirds for all of last year.
And while that week was the worst since 2012, it wasn’t a one off. Auction clearance rates have averaged in the mid-to-low 50 percent range for each of the past nine weeks.
The recent weakness in the Australian housing market, which has been one of the drivers of an economy that has now grown for 27 years without a downturn, has some economists warning of heightened risks of a recession and even a financial crisis.
In anticipation, some hedge funds are shorting the nation's financial assets and some significant investors are heavily underweight Australia compared to regional benchmarks.
The slack has been partly engineered by the authorities. Curbs on lending to foreigners, foreign buyer taxes and a clampdown on capital flows by Beijing have hurt bubbling demand from Chinese investors, who have been important contributors to the housing boom of recent years.
There are signs of a similar fall in Chinese investment in Vancouver, Canada – which has also been a red hot market in recent years and where the authorities have also intervened by raising taxes on foreign buyers. But a decline in Vancouver’s sales is yet to translate into price declines.
In Australia, a government-mandated inquiry into the nation’s banks has turned up so many misdeeds that the industry has restrained some lending. Annual growth in housing credit has braked to four-year lows while building approvals have come off a peak and nationwide home prices have started to fall for the first time in six years.
Home values in Sydney, the country's largest city, are down 4.4 percent compared to June last year, the sharpest fall since 2008 and far away from the 19 percent growth enjoyed early in 2017, according to property consultant CoreLogic
The annual price increases in Melbourne and Brisbane have braked to around 1 percent, down from double-digit growth last year.
Investors are taking note.
"We have shifted a greater proportion of our assets offshore as an intensifying slowdown in housing is likely to increase downward pressure on the Australian dollar," said Ben McGarry, Sydney-based portfolio manager at A$185 million hedge fund Totus Capital.
He said the fund is "short a selection of Australian retail, construction materials and banking stocks which have benefited from the long bull market in Australian housing,” but declined to identify specific companies.
And a unit of UK fund management group Aviva Investors has taken short bets against Australian assets in the credit and currency markets as the odds of a housing-related downturn have increased, a spokesman for the firm told Reuters on Monday. He also wouldn't detail the bets.
The Australian dollar has fallen more than 5 percent against the U.S. dollar since the beginning of the year.
And there is growing short interest in companies such as building products maker CSR and mortgage insurer Genworth.
Some funds whose policy is to refrain from taking short positions have still reduced their exposure to Australia.
London-based Liontrust Asia Income Fund has 7.5 percent in Australia, against a benchmark of more than 17 percent based on the MSCI Asia-Pacific Ex-Japan index, according to fund manager Mark Williams.
"We have a very low weighting in the banks, where if we have any real selloff that's where it would feed through," he said.
And California-based Pacific Investment Management Co (PIMCO), one of the largest actively-managed bond funds in the world, says it "is cautious on housing-related investments" in Australia, according to Dan Ivascyn, its group chief investment officer.
A modest cool down would be welcome.
The Reserve Bank of Australia (RBA) has long worried that the speculative bubble in the property market could burst like it did in the United States, hammering banks and the economy.
Mortgages amount to A$1.8 trillion, or just over 100 percent of the country's annual economic output (GDP). That compares to around 91 percent in the UK and 80 percent in the U.S.
A stress test by Australia's banking watchdog conducted in 2017 showed that if home prices fell 35 percent, unemployment doubled to 11 percent and GDP fell 4 percentage points, Australian banks would lose A$40 billion on mortgages alone.
But regulators have forced them to squirrel away so much capital that the banks would still be solvent, the test showed.
Policymakers have also clamped down on banks’ mortgage lending over the past couple of years, including stiff curbs on buying properties for rent.
This has pushed many speculative buyers out of the market, which is good news for prospective buyers.
"I have been waiting for this slide to start," said Arif Hossain, 37-year old biomedical engineer in Western Sydney, who is looking for a four-bedroom house.
"The properties that I am looking for were selling around A$1 million just some months back. They have now fallen below A$900,000 but still there is no sale," he added.
He wants prices to drop to A$750,000-A$850,000 before jumping in.
But such declines could be very painful.
The government estimates Australia's 10 million homes are worth A$6.9 trillion, close to the annual GDP of France and Italy combined.
The value of the housing stock has swelled by A$2.3 trillion in the past five years, a windfall to consumer wealth at a time when wages have stagnated.
With prices now in decline, the wealth effect could easily turn into a headwind. Already, households suffered the largest loss on land and dwellings in six years in the first quarter.
"The consumer was already the weak link in Australia's growth story," says Westpac senior economist Matthew Hassan. "The housing correction represents additional downside risk to the outlook."
Australia has dodged threats of a downturn during the good times. Beijing helped bail Australia out during the global financial crisis as Chinese stimulus spending drove demand for Australian resources.
Yet, that has left China with a debt hangover at a time when a trade war with the U.S. threatens to throttle its exports. In some senses, Australia is as exposed to China's housing price bubble as it is to its own.
But options for Australia's policymakers are constrained.
The central bank has slashed interest rates to a record low of 1.5 percent and the government has just committed to a seven-year plan of tax cuts. The latter, though, won’t deliver a cent of stimulus until mid-2019, with most of it not due until 2024/25.
"With credit conditions set to tighten at a time when household debt is at a record high and house prices are already falling, the risks of recession and financial crisis have risen," warns Paul Dales, chief economist at Capital Economics.
He sees a 20 percent chance of a recession without a financial crisis, and a further 10 percent chance of both happening.
"Put another way, there's almost a one-in three chance that the surge in household debt ends badly,” he warned. ($1 = 1.3439 Australian dollars)
Reporting by Swati Pandey and Wayne Cole; Additional reporting by Jennifer Ablan in New York and Simon Jessop in London Editing by Martin Howell