Looking at a recent chart of share prices, you’d think shares of some Latin American companies were on fire and might be tempted to jump in for double-digit gains.

#-ad_banner-#Shares of the Global X MSCI Argentina Fund (NYSEMKT: ARGT) are up 28% since February lows, only bested by a 31% gain in the iShares MSCI Brazil Capped ETF (NYSEMKT: EWZ).

As an analyst, and someone who lives in the region, I follow the markets and political moods pretty closely. Last November, I warned investors about Brazilian companies and a 21% decline in the market followed. In July, I wrote another article warning investors about Brazil.

To those warnings, I am now adding shares of Argentine Banks.

Don’t get me wrong, I like double-digit stock returns as much as the next investor. And I believe that emerging markets offer the best opportunity for long-term profits. But if you are not following the political and economic situation closely in these markets, you are setting yourself up for big losses.

A downward spiral in Argentina

If you have not been following developments in Argentina lately, you’ve missed drama to rival any day-time soap opera. The country defaulted on its debt in July and has yet to make the payment.

The default comes after a U.S. judge said the country must negotiate with creditors still holding bonds from its 2001 default. Argentina has refused to negotiate and payments on its bonds have been blocked.

But that is not why I am warning investors on local banks.

The Senate voted in favor of a new price control bill earlier this month. The bill will allow the government to limit profit margins, set price ranges for products and establish minimum production levels. This attempt to control production at the most minute detail has been tried in Venezuela since November 2011 and has led to shortages and a 90% depreciation in the local currency.

On September 4, the central bank also announced that private banks must lower dollar-denominated assets to 20% of total assets from the previous 30% rule set in February. The move is an attempt to free  dollar reserves that the central bank can use to pay foreign debt. This will remove any protection the banks have against higher inflation and further depreciation in the peso. Combined with falling economic growth, it may be the last straw that breaks the financial system.

The government has not released an official figure on inflation since February, but private estimates show prices have surged 38% over the past year, the highest in the region after Venezuela. Argentines tend to rush to the dollar in times of crisis. And now the country’s foreign exchange reserves are quickly being depleted — falling by more than $2 billion this year to $28.6 billion, the lowest in nearly a decade. The value of the peso has dropped 22% already this year after a devaluation in January, the worst among the emerging market currencies tracked by Bloomberg.

Bank of America estimates that net liquid reserves, reserves used to pay debt, will fall to $8.8 billion and will not be enough to pay $10 billion in debt next year. While the financial system has held up relatively well since the technical default in July, the lack of reserves could cause a much more serious run on the currency.

To demonstrate how risky these investments are, let’s look at an Argentine bank:

Grupo Financiero Galicia S. A. (Nasdaq: GGAL) is the fourth largest Argentine bank by deposits and has a market cap of $1.77 billion.

Nearly all (84%) of the bank’s loan portfolio has a maturity of less than one year, which helps to minimize rate risks but leaves it incredibly at risk to a drop in loan demand on the economy. Asset quality has been declining over the last few years with the default rate on consumer loans surging to over 9% in June.

To prop up performance, the bank has lowered the amount it holds against loan losses, now at just enough to cover non-performing loans. Any increase in default rates from here will not be covered by reserves and will eat into profits. The shares pay a dividend of just 0.2% and trade for 6.5 times earnings.

But you do not have to totally avoid the region

Against the spiraling economic scenario in Argentina and Brazil, Chile and Colombia offer attractive alternatives for investors looking for those long-term emerging market plays.

The economy of Colombia surged 5.6% in the first half of the year, while many of its regional neighbors fell into recession. The central bank has increased interest rates and the government is proposing reforms to increase access to the financial system.

The nation’s largest bank, Bancolombia (NYSE: CIB) has a market cap of $13.6 billion and pays a 2.6% dividend yield. Shares trade relatively expensively at 15.9 times earnings, but still well below the 17.1 average price multiple on U.S. banks.

The economy of Chile has weakened along with copper prices, but the central bank is still forecasting growth of 2% this year. Despite the recent weakness, Chile has long been the model for economic growth in the region and has a sovereign reserve fund worth $8.2 billion that it can use to support the economy.

Banco de Chile (NYSE: BCH) has a market cap of $11.9 billion and pays a 3.9% yield. Shares trade for a significant discount at just 11.3 times trailing earnings on the recent economic weakness.

While other regional banks may not be as attractively priced as their Argentine peers, investment risk is much lower and dividend yields are attractive. The two Argentine banks above both have betas well over 2.0, meaning they are twice as risky as the general market, while the Chilean and Colombian alternatives have betas nearly on par with the market.

Risks to Consider: Super-low price multiples in emerging market financials have a way of drawing investors looking for that big payday. Shares of Argentine banks could continue their double-digit gains on the exuberance of late but larger fundamental problems are likely to hit eventually.

Action to Take –> Avoid the temptation to chase returns in Argentine banks as the government looks to be a bigger manager in the economy and refuses to settle debt problems. The government has already raided pension funds and may continue on to other financial assets to shore up reserves.

Look to regional peers in Chile and Colombia for long-term returns and consider shorting Argentine banks as a hedge against weakness across the region.

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