Combine the first 6 ingredients in a large saucepan. Bring to a boil; cover, reduce heat, and simmer 20 minutes.
While the peppers are cooking, place bread in a food processor; pulse 10 times or until coarse crumbs form to measure 1/2 cup. Combine breadcrumbs, beef, and next 6 ingredients (beef though garlic) in a bowl, shaping mixture into 36 (1-inch) meatballs. Heat olive oil in a large nonstick skillet over medium-high heat. Add meatballs; cook for 10 minutes, browning on all sides.
Combine flour and 1/4 cup water in a small bowl; stir with a whisk. Add to bell pepper mixture in saucepan. Add meatballs; cook 3 minutes, stirring constantly. Stir in the basil and vinegar. Remove bay leaf.