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.

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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.

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), Vale ( RIO) and Ultrapar ( UGP) 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), 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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