“当他拎着装在袋里的一只大油饼往回走“ in this sentence ,“装“would not be a veb.it should be get the meaning from“装在“，the word means sth. Is be putting in where(eg.bag /box....),so for this sentence,“一只大油饼 is be putting in a bag (装在袋里），and 他拎着这个袋子往回走。or you can understand it like “当他拎着一个袋子（袋子里有一个大油饼）往回走，……

My understanding of this is: 装在袋里 = pouch, so "当他拎着装在袋里的一只大油饼往回走，经过他们身边时，他们的话断断续续飘入他的耳鼓:" = "As he turned to go back, carrying a big cake in (his) pouch, he passed by them, their words floating intermittently into his ears:". I would interpret your sentence "当他在袋里拎着一只大油饼往回走..." as meaning: "As he was inside the bag (he) turned to go back, carrying a big cake...". This is because 他 is immediately followed by 在袋里, which makes it sound like he is in the bag. Therefore, the verb must come after 他: 他拎着... which is then followed by the adjective (装在袋里的) to the following object (一只大油饼). Word order is crucial in Chinese~

袋 is the bag (袋子) in this sentence. 装 in this case means 'placed in/put in', so that part of the sentence, when translated, should mean 'he's carrying the bag in which there is a 大油饼' :) You suggested writing 当他在袋里拎着一只大油饼往回走, but this is structurally incorrect as it would literally means 'he is in the bag holding a 大油饼 and walking backwards'.

in this sentence, "装在袋里的“is an adjective.

No, I can't be "当他在袋子里拎着一只大油饼往回走” . Well I can translate these into english ,then you'll know why When he was in a bag = 当他在袋子里 having a big pie in his hands = 拎着一只大油饼 当他拎着装在袋子里的一个大油饼 = when he had a big pie which was in a bag well, then you understand?