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There are a few popular theories on why that is. When you sleep, the parts of your brain that govern perception never shut down, but the parts that process input and allow us to define "reality" and our position in our world DO shut down. Dreams are, for the most part, just our imaginations running wild without the more civilized parts of the brain keeping it in check. The perceptive parts of our brain, seeking input, latch onto these imaginative wanderings and make them seem real.

At the same time this is going on, the brain is also "recharging" itself by allowing its neural receptors to rest. As the brain rests, it appears to randomly "test" itself by firing off signals to various neurons for reasons we don't quite understand. It's quite likely that the "faces from the past" phenomena happens when one of these random firings hits a neuron holding a long forgotten memory, and more complex dreams happen when the imaginative parts and perceptive parts of the brain try to make sense of these signals.

For example, one random neuron firing may remind you of a conversation you once had with a friend. Another random neuron firing may remind you of your grandmothers living room. Another random neuron firing might bring back the long forgotten face of a girl you once knew. Trying to make sense of these signals, the imaginative part of your brain combines them into a scene where you're sitting in your grandmothers living room talking to a girl you haven't seen in decades as if she were an old friend. Since the parts of your brain that separate reality from fiction are sleeping, the imagination takes that premise and runs with it, building a complete dream.