Trading Tax Could Cut Everyone

NEW YORK (TheStreet) -- Proposed legislation in the House of Representatives aimed at making Wall Street pay for the bailout of financial firms could have unforeseen consequences -- even for mom-and-pop investors. That's why lawmakers need to think long and hard before they decide to vote on it.

The proposed bill (H.R. 1068: Let Wall Street Pay for Wall Street's Bailout Act of 2009) would put a damper on banks like JPMorgan Chase(JPM Quote), Goldman Sachs(GS Quote) and Morgan Stanley(MS Quote), whose results have benefited from trading operations.

Its passage, which would add a 25-basis point tax on securities transactions, could cripple the high-frequency trading market that has sprung up in place of human market makers since the decimalization of trading. That would cause spreads to widen, and money would move to less-regulated forums. This would result in lower liquidity for average investors in markets with the new regulation and increased risks for those who venture outside.

When taxes or restrictions are placed on certain securities transactions, Wall Street finds new ways to trade. This is a trend that has played out recently in the exchange-traded fund industry, exposing investors to new types of credit risk and overseas contracts.

Need an example of how regulation can unintentionally result in more risk to the consumer? A war is being fought over futures-based commodity ETFs, and as the Commodities Futures Trading Commission places new "safety limits" on New York Mercantile Exchange-traded futures contracts, ETF managers are shifting toward alternatives.