French and German finance authorities have started quietly putting together an emergency 3 tier strategy as fears escalate that the sovereign debt crisis of the Eurozone is beginning to spin out of control. They are aiming to construct a kind of firewall around Ireland, Portugal and Greece that would prevent any crisis from moving out into Spain and Italy, countries which it is generally accepted would be too large to bail.

EU insiders claim there has been good progress at the G20 in Washington when leaders of numerous countries pressured the Eurozone members to fix their problems before they lead the world back into another recession. Indeed they issued a communiqué which set a 6 week deadline for the resolution of the crisis, to be announced on the 4th November at the G20 meeting in Cannes.

In the first stage, European banks would be recapitalized with 10’s of billions of Euros reassuring the markets that Portugese or Greek defaults would not start a complete financial and systemic crisis. Such a plan to recapitalize would go a great deal further than the £2.2 billion needed by regulators after the European banking stress tests last July.

Secondly they plan to shore up the EFSF. European economists have now estimated that the Eurozone would be needing about two trillion euros worth of firepower if they are to cover Spain and Italy’s financing requirements if the two countries were to be closed out of markets. European officials are trying to work out a way to get the EFSF leveraged through the ECB (European Central Bank) to attain the target.

Finally, such a complicated deal would also include the EFSF providing some kind of loss capable equity tranche of the European Central Bank and any bailout fund with the rest becoming protected debts. If the EFSF was to bear the first twenty per cent of losses, the war chest of the fund could then be boosted by 2 trillion Euros. If the EFSF was to bear forty per cent of the loss then the fund would still deploy one trillion Euros.

James is an economist and financial journalist. He blogs about all things financial, from loans to interest rates and from mortgages to payday loans.