UPDATE 3-Lone Star to buy German subprime casualty IKB

(Writes through, adds background and detail or purchase price)

By Patricia Uhlig and John O'Donnell

FRANKFURT, Aug 21 (Reuters) - U.S. private equity investor Lone Star [LS.UL] is buying the rump of lender IKB (IKBG.DE: Quote, Profile, Research, Stock Buzz), Germany's most prominent casualty of the subprime crisis.

The sale by state bank KfW closes an embarrassing and costly chapter for Europe's biggest country and most powerful economy.

IKB nearly collapsed a year ago under the weight of $24 billion in investments linked to risky U.S. home loans, making it Europe's first major victim of the global financial crisis.

Then the government brokered the first of three rescues to avert what the country's banking watchdog warned could trigger Germany's biggest financial crisis since the 1930s depression.

But as the cost of the rescues spiralled towards 10 billion euros ($14.8 billion), Berlin started looking for a buyer.

On Thursday, KfW announced that the stock-market minnow would be sold to Lone Star and that it and the government would take responsibility for a further 1.3 billion euros of IKB's battered portfolio which has roughly halved in value.

The remaining 3.3 billion euros of dud investments will go to Lone Star, which will house them separately from IKB's main business of lending to small and medium-sized German companies. They, too, are worth less than half what IKB had originally paid.

The government had hoped to recoup some of the money it paid to resuscitate IKB.

But sources close to the matter said on Thursday that the purchase price was about 100 million euros -- a fraction of the 800 million euros finance minister Peer Steinbrueck had originally hoped for.

The deal, KfW said, meant that it no longer faced substantial risks from IKB, drawing a line under an episode which made Germany one of the countries outside the United States worst hit by the subprime storm.

Many Germans had known little about IKB, which lends to one in 10 of Germany's top companies, before its near collapse.

Its troubles sparked a bitter row in Berlin as to who was responsible for the bank's mistakes and who should now pay for the clean-up.

It also prompted criticism of Steinbrueck for mishandling the matter as well as junior finance minister Joerg Asmussen, who sat on IKB's supervisory board.

The credit crisis, which started when U.S. home owners were squeezed by falling property prices and rising interest rates, rocked the market for securitised debt and dragged down the global economy.

(Editing by Elaine Hardcastle and David Cowell)