The U.S. government should take stakes in banks in order to recapitalize them rather than instituting a $700 billion bailout package, as the economy is one step away from depression, Hugh Hendry, chief investment officer and Partner at Eclectica Fund, told CNBC on Thursday.

"The issue with the banking sector is not one of liquidity. They are drowning in liquidity. They're bust because they are leveraged," Hendry told "Squawk Box Europe."

He said the U.S. government should follow the example of legendary investor Warren Buffett and of sovereign wealth funds and buy stakes of between 30 percent and 50 percent in banks.

"The private sector doesn't want to bet on another bad horse. It calls for the government to act as a lender of last resort," Hendry said. "The leverage would immediately collapse. You'd have recession, but you'd have a chance of averting depression."

The government's bailout plan is unpopular because it is asking taxpayers to pay more than the market value for bad assets, and they are outraged, he said.

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