They should overclock moderately with a half-decent motherboard. They can typically go from anywhere between 2.6 GHz-3.4 GHz on air. I managed to get my Winsor 3800+ X2 from 2 GHz to 2.8 GHz with ease.
To the threadstarter, yes your CPU is holding the GPU back somewhat because you're mixing a 260GTX which was considered a high-end GPU last year with a low-end Athlon X2. I would say your best option is to overclock the CPU slightly which the guys here at TPU wouldn't mind helping you with if that is an option you want to explore.
There is no point getting a faster Athlon X2 because the 4200+ is more than capable of overclocking to the same spec as a higher model such as the 5600+ X2 @ 2.9 GHz and your bottlenecking should be reduced massively. Alternatively if overclocking does not appeal to you I would advise replacing the CPU with a AMD 7750+ for $50-60 for a quick fix or a X3 720 BE if you're serious about gaming.
PS. Although you wouldn't see the full potential of the GPU games should still play fine with your current rig at 1440x900 you'd definitely be able to run most games a medium to high with respectable frame rates without the OC and without the new CPU.
I'd agree with you that the X2 3800+ (Manchester; 939 socket) was good at overclocking. I took the one I had from stock speeds (2.0 up to almost 2.7 on air cooling).
As for the X2 5600+ (Windsor) I had I couldn't really OC it very well. No matter what I tried to do, I couldn't get it stable past 3.15 (from stock 2.8). With that 5600+ I was running my 2x 8800GTS 512MB in SLI - I was bottlenecking the SLI setup pretty bad.
You will bottleneck a GTX 260 (my 8800GTS 512MB in SLI run about 20-30% less in performance over the GTX 260 216 in high resolutions). Working on overclocking your CPU will help eliminate some of the bottlenecking, but not all of it.
You will see a good jump in performance over any 8xxx series card by stepping up to the GTX 260. You would just see better performance if you had a better CPU. There's nothing really wrong with what you have, but it's not that great either. Your CPU will get you by for another couple of years if you truly do not want to upgrade anytime soon.
Just to give you an idea of how much I was bottlenecking my GPUs with my 5600+; In 3DMark06 on the first GPU test, I would get around 70-75fps at the start of it and during many parts I would dip down to the teens. With my Phenom II x4 940 I have now, the first GPU test in 3DMark06 I run at the start in the mid 100s and I only dip down into the low 30s/high 20s in one or two spots.