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Brazil's Risk Factors: Crime and Corruption

I had a personal encounter with the police in Rio de Janeiro that spotlights the fraud and ugliness. Just after landing with a friend in Rio, we went for dinner. On our return to the hotel around 10 p.m., we ran into what locals call a "police blitz." Basically, it was a police checkpoint.

But this was no checkpoint we have ever been to. It was full of heavily armed military police officers wielding attack machine guns and unholstered side arms being waved around.

Even stranger, all of this was taking place in a very nice section of Rio, comparable to the Upper West Side of Manhattan or the Gas Lamp district of San Diego.

These twisted defenders of law and order immediately told our taxi driver to pull over and pointed for us to get out vehicle. We were yelled at, harassed and thoroughly searched, but nothing was found. The only way to describe what ensued was the worst theatrical performance of "good cop, bad cop" I have ever seen.

"Want to go to jail?" the bad cop screamed. You name it. They did it.

Luckily, I can speak conversational Portuguese, so I could communicate and understand what they wanted -- it was a shakedown, and they wanted money. I actually think I came out on top in our "negotiations" in which we settled on giving them R$45, or USD$28.

This was a small shakedown, but the history of Latin America is littered with stories of bigger shakedowns and the ruins of banana republics toppled by corruption. And Brazil is clearly no exception.

Yes, the insatiable global demand for commodities can keep Petrobras (PBR - Get Report), Vale (RIO) and Ultrapar (UGP - Get Report) going higher, but if Brazil seeks the next level, the middle-class consumer needs to form and grow.

If this happens, look for stocks like Banco Bradesco (BBD), Banco Itau (ITU), Unibanco (UBB), Companhia Brasileira (CBD - Get Report), Gafisa (GFA), Saneamento Basico (SBS) to explode higher.

To continue and expand their road to prosperity, Brazil must first and foremost recognize the enormity of this problem, how ingrained and widespread it is, and do whatever it takes to fix it. Call it restructuring, call it whatever you want. Just fix it because only then, can Brazil move to the next phase of growth.

This was originally published on RealMoney on June 27, 2008. For more information about subscribing to RealMoney, please click here.

Patrick Schultz is a research associate at TheStreet.com. He has previously obtained securities licenses under the NASD's Series 7, Series 24, Series 52 and Series 63 exams and has worked in the financial markets on various trading desks in addition to trading for his own account. Schultz holds a bachelor's degree in applied economics from Cornell University.
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