Reciprocal links are touch and go for a few reasons.
The reason that incoming links are good is that search engines think your site is worthwhile if humans are linking to it. In other words, if a webmaster reviews your content and links to it then your content must be good (thinks the search engine).
So people actively started to try and build links, to make search engines think that their content is good.
The only thing is that search engines hate it when you do things just to optimize your site for search engines. Optimize your site for users, while making it easy for search engines to see what it's about (this is where the bold, italics, page title and headings come in)
Search engines see reciprocal links as a distortion. The webmaster is not linking to you because your content is good, they're only linking to you because they're getting something in return (a link to their site, or even money). If you have a page of links that link to sites that are linking to you a search engine is going to realize that none of those links actually mean anything. They're going to think that you're trying SEO "tricks".
Google specifically warns against "excessive" reciprocal linking, but doesn't quantify this. So if you find a nice juicy site that insists on a reciprocal link then fine - give them a link from an article. Never create a page of reciprocal links to a whole bunch of worthless sites that are irrelevant, or have low page rank. Think how easy it would be for a search engine to spot this.
Google puts this a whole lot better than I can (in their Guidelines for Webmasters) when they say "make pages primarily for users, not for search engines. ... Don't participate in link schemes designed to increase your site's ranking or PageRank."
They expand on this when defining link schemes.
Two better alternatives to reciprocal linking are to use link bait and to submit your site to RSS aggregators. Don't go rushing off to build hundreds of reciprocal links to other sites. Rather spend your energy building your site into a great resource that people will want to visit (and link to).
By the way, to report a site that is using link spam you can use the Google tool: http://goo.gl/linkspam . If you can use this tool, then your competitors can use it on you too.