The local government ombudsman Patricia Thomas delivered a damning verdict after hearing how the carer was given virtually no advice, money or support to help him look after the 17-month-old boy, known in the report as 'Harry'.
Even when the carer complained to the council about his mounting financial difficulties, officers failed to interpret his letters as formal complaints.
For a year, the carer - known in the report as 'Mr Elliott' - was making decisions about the baby's future which he had no legal right to make.
'Had the council treated Mr Elliott's letter in February 2003 as a complaint and dealt with it accordingly, the matter might have been resolved and relieved him of what became a further 12 months or more of financial difficulty,' she said.
The council has agreed to pay Mr Elliott the compensation. Head of childcare Steve Titcombe said: 'We have learned from these mistakes, and procedures within the Child Care Service have been improved.'