I doubt the consequences will be allocated appropriately. Some of these ridiculous mortgages were sold to hedge funds and in that case the risk is likely to be allocated appropriately.

At this point, his first mortgage is toast, so hedge funds and pension funds will take a hit regardless.

If the guy is already has a house, the next purchase has to show as a Non-Occupied status (can’t be in both at the same time).

Can’t you buy a house with intention of converting your existing house into rental?

it will be difficult to get another loan when he is already cash flow limited

The original post says that the buyer qualifies for the loan full doc. It’s not incredibly hard to do that. His current monthly payment could be as low as $3000 (he has an Option ARM) and, if he brings 80k in cash, he can get a conforming mortgage on the second house for $2500/month. Add taxes, insurance, etc. and he could be qualified with as little as $150K annual income.