Laura, you have just put forth one of the real classic philosophical questions, usually referred to as "The problem of Evil." Philosophers and theologians have wrestled with it for centuries, and I doubt that Mudcatters are going to do any better.

The attempts I've seen at resolving it include:

1. Free will is purposely allowed, even at the cost of evil, in order to allow mankind to reflect their made-in-the-image-of-God power of choice.
2. God is not all powerful (or)
3. God is not all good (or)
4. God, while all good and all powerful, is not attentive--he just doesn't pay attention to us and our actions, so evil in effect goes on behind his back.
5. God is in essence not one but two, one dedicated to good and one to evil, of approximately equal powers. The evil side or evil being is close to the idea of Satan. The idea is that there is a titanic struggle going on, but that the good side will eventually triumph. This is the Manichean heresy, one of the historical heresies upon which the early church nearly split. This idea is embodied in the ancient (and still barely existing) religion called Zoroastrianism.
I've heard it suggested that God, being basically good but containing evil within himself, got rid of his evil by placing it in another being, which his good side could then defeat.

There may be other approaches, but these are the ones I'm familiar with.

Dave Oesterreich