Reductions in gamma band phase synchrony and evoked power have been reported in schizophrenic subjects in response to auditory stimuli. These results have been observed in the EEG at one or two electrode sites. We wished to extend these results using magnetic field data to estimate the responses at the neural generators themselves in each hemisphere. Whole head magnetoencephalographic (MEG) recordings were used to estimate the phase and amplitude behavior of sources in primary auditory cortex in both hemispheres of schizophrenic and comparison subjects. Both ipsi- and contralateral cases were evaluated using a driving (40 Hz modulated 1 kHz carrier) and a non-driving (1 kHz tone) stimulus. We used source space projection (SSP) to collapse the magnetic field data into estimates of the time course of source strengths in individual trials. Complex wavelet based time-frequency decomposition was used to compute inter-trial phase locking factor (PLF), and mean evoked and induced amplitude for each cortical generator. Schizophrenic subjects showed reduced SSP PLF and evoked source strength for contralateral generators responding to the driving stimulus in both hemispheres. For the pure tone stimulus, only the left hemisphere PLF's in the transient window were reduced. In contrast, subjects with schizophrenia exhibited higher induced 40 Hz power to both stimulus types, consistent with the reduced PLF findings. The method of SSP combined with wavelet based complex demodulation produces a significant improvement in signal-to-noise ratio, and directly estimates the activity of the cortical generators responsible for gamma band auditory MEG evoked fields. Schizophrenic subjects exhibit significant impairment of generation and phase locking of this activity in auditory cortex, suggesting an impairment of GABA-ergic inhibitory interneuronal modulation of pyramidal cell activity.