Or vice versa.

House has been on a short sale for many months, the house whose deed is on one of the two.

The other party has an excellent credit with income and cash.

Can the other party buy a house, legally and/or ethically?

Yes, both are legally married and have been living together for the past 10 years in the house of the short sale.

If they both are on the mortgage and deed to the home in short sale, which usually means behind on payments, they will not be able to purchase a new home.

It may be possible if the spouse buying is not on the mortgage nor on the deed to the house in short sale. But this is clearly a strategic default and if the new mortgage company even catches a whiff of it, they will find a way to decline them.

Strategic default is not a crime by the way. The new lender will not care if only one spouse is on old house, and the other on new house. As long as the buyer qualifies on their own, they could care less about the spouse.
I actually have a short sale like this right now. 3 years ago the couple had a house in his name only they short sold. She was unaffected so right after they bought a new house in her name. Im actually short sellimg that house right now, but since she is the only one on title/mortgage, he is unaffected by THIS short sale. Back and forth they go. They have decided against home ownership going forward.

These two sound like a couple of real losers. Better hope there is money to pay your commission. Their next move will be to stiff a landlord at some point. Sounds like not living up to their word is built in to their personalities. I don't deal with people like this, and neither should you. You actually become an accessory to their immoral conduct.

Sh*t happens. People make regrettable decisions everyday.
Not my place to judge...just facilitate. I'm not the moral police.
And don't worry - I always get paid.

The loan underwriters used to never care as long as the borrower they were underwriting hadn't short saled, but not so much now. My loan officer told me about someone recently who got declined and the reason given was very vague. When pushed the underwriter stated that the spouse had done a short sale less than a year ago and they were not interested in the borrower. Unsusre how they found out, but even if houses are purchased separately, there are always some ties between spouses. The underwriter stated if they could prove that they were no longer living together than she would consider the loan.

I believe that banks are tryiing to pinpoint who may be a strategic defaulter and who has to default due to no fault of their own. They don't want the ones that look like strategic defaulters. Whether it's legal or not is still to be decided. Several banks have lawsuits against borrowers pending. The banks are trying to prove bank fraud and that the borrower never intended to repay the loan. The borrowers, however, feel that the contract states the remedy if they default. We'll have to see who wins.

I actually highly doubt many people get into loans with the goal of defaulting. That seems silly. Why go through all the effort and put money down with the goal of default knowing you will just trash your credit and lose the house. whats the point?
I think they default later as a result of their circumstances (lost value, change in income, etc) but no LO could predict that upfront.

I agree to a certain point. Many went into the loan with no money down knowing they could sell later and make "ALOT" of money. They had a vision that never happened. Many knew they were over paying for a property, but real estate values only rise. Then they pay for 10 years to find out they still owe more than the house is worth. Sadly thats the chance you take when you invest in anything.

Yes - and those loan programs are all gone now. I think the odds of someone getting into a loan TODAY with a goal of default is even lesser.

I agree.