If I understand the situation correctly, the home was listed as if it was being sold by an owner with no indication that it was an REO property. Is that the case? If so, it could have been simply a mistake of the listing agent. Many of them are so swamped with bank owned properties that putting in accurate information into MLS is simply not a priority.... unfortunately.
Now to get to the answer of your question regarding the actual ownership. Believe it or not, but some REO sellers actually list their properties before they have actual posession of the property. I do a large volume of REO sales with my buyers and I frequently see that in their bank addenda they put clauses such as "offer subject to final court ratification" or something to that effect. I am involved right now in one where I just got an email from seller's rep telling us that court ratification was delayed and we need to extend settlement by a month.
Furthermore, most folks do not realize that legal ownership of property actually transfers upon ratification of the contract or, in REO case, at the foreclosure auction.
So yes, the bank can sell the property even though the deed with transfer from previous owner to the bank is not recorded. In most cases that I've been involved in, the ownership from previous owner to trustee to the bank then to new owner happen in one transaction (when you buy the home). I have also been involved in cases where the bank, after a couple of months, simply tells the buyer that the foreclosure proceedings were not done correctly and the property can not be sold. That has happend to me twice in the last 3 years.
Bottom line Ashley.... Please make sure that you're working with competent individuals - your agent and your title co. REO deals are a lot more complicated then they seem and not everyone is equipped to handle them. I am not saying this to scare you at all. I am pretty sure that you'll be just fine. Lastly, I am not an attorney and if you feel something is seriously amiss, you should seek legal counsel immediately since I am sure you have some money at stake not to mention time.
I would be happy to answer any of your subsequent questions. Good luck!