Brazil's Risk Factors: Crime and Corruption

Editor's note: This was originally published on RealMoney. It is being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

In Parts 1, 2 and 3 of this series, I expressed my bullish view on Brazil, led by a rich bounty of natural resources and a burgeoning middle-class. To avoid accusations of pushing Pollyanna ideals, in this final installment, I will detail the still deep-seated problems in Brazilian society and markets.

The plague of crime and corruption is the biggest bearish argument against the sustainable growth of Brazil's economy and bigger market gains. It is a corrosive and threatening crisis because as we all learned in high school, the foundation of any prosperous and civil society or market takes root in the rule of law.

Investors must have an absolute and unconditional belief that the system is untainted (higher confidence equals higher PE multiples). Lacking an honest system of checks and balances, investment and commerce cannot exist.

China Watch: Brazil's One Way In (Video)

One way to get in on the action with China is to play Brazilian companies with Chinese connections. Patrick Schultz reveals how we can play one emerging market to play another.

To watch the video, click the player below:

Plus, don't miss China Watch Mail Bag: Best Brazil Bets.

The majority of the challenges stem from the notoriously large gap between rich and poor in Brazil. For many generations, there was no such thing as a middle class. Additionally, most people on the lower end of the economic scale had no opportunity to rise out of it. In many cases, crime was the only opportunity offered. However, with the country's recent boom, there is a newfound optimism.

The most alarming aspect of the corruption is that it does not consist of petty crime and lone actors. It is a systemic and institutional issue that will dismantle and crush all its recent progress.

Even high-ranking government officials are on the take. The glaring example is former president Fernando Collor de Mello in 1992. He was forced to resign to avoid impeachment over influence peddling schemes that funneled millions of dollars into accounts set up by his campaign treasurer (who was later murdered).

A more recent example comes from Paulo Maluf, the former Mayor of Sao Paolo, the largest city and commercial hub of the nation. He was arrested for diverting hundreds of millions of dollars to personal Swiss and Channel Island bank accounts.