I am building a MAME cabinet and I am using a keyboard controller to interface the joystick and buttons to a computer. I want a LED indicator to show when a button is being pressed. I am just a novice with electronics and I am worried that I will blow up the controller. Please have a look at the schematic below and let me know if this will work. Note, the 5v supply is coming from the PS2 port.

 

Most keypads/controllers nowadays are digital. The keypads don't have real "switches" in them as such; they merely change the capacitance in a circuit that the keyboard controller detects during a scan.

The keyboard controller "talks" to the computer in a defined protocol of a series of bits.

With the information you've provided thus far, it's impossible to say for certain whether it would work, not work, or even damage/destroy your equipment. I suspect that with your current idea, it will not work as you hope it would, with the information provided so far, and that you may damage your equipment by attempting to connect it up.