The opening to the game gave few hints to the drama to follow, but once the deadlock was broken after 21 minutes it was a rollercoaster ride all the way.
A Jamie Carragher own goal gave the Hammers the lead, as the Reds defender turned a Lionel Scaloni cross into his own net.
Seven minutes later it was 2-0 as Jose Reina spilled a Matthew Etherington drive from 20 yards and Dean Ashton was on hand to bundle home the rebound.
However, Liverpool were back in the game four minutes later as Steven Gerrard's long pass played in Djibril Cisse and the Frenchman crashed home a superb right-foot volley.
The Hammers kept their advantage until nine minutes into the second half when a quickly-taken free-kick caused chaos in the box and Gerrard flashed home a blistering right-foot shot from 12 yards out.
Just as Liverpool thought they had the upper hand, West ham retook the lead as Paul Konchesky's cross from the left sailed over Reina and dipped just inside the far post to make the score 3-2.
That looked like being the winning goal until Gerrard produced an astonishing injury-time match-saver, latching on to a loose ball all of 35 yards out, he drilled a howitzer of a shot beyond the despairing dive of Shaka Hislop.
Extra-time proved to be far more sedate, with both sides having a number of players suffering with cramp.
However, with seconds left to play a free-kick into the box forced Reina into a desperate finger-tip save against an upright and Marlon Harewood sliced the rebound wide with the goal gaping.
That ensured a penalty shootout and Reina was again the hero as he saved from Bobby Zamora, Konchesky and finally Anton Ferdinand to hand the Reds some silverware and leave the Hammers heartbroken.