How it works is, say you have uploaded a huge number of photographs, Facebook will group together the faces that look similar, based on the premise that they are photos of the same person. Facebook also goes and looks into the past photo tags and suggests who in the picture.
Facebook believes the new feature will simplify the process of photo sharing. Also for users who want to maintain their privacy and not have their name suggested, they can use the privacy settings of the site and turn off the feature.
The earlier face detection feature allowed users to only tag the photos and not suggest the faces. This feature is included with the recent profile update of facebook.
Entire Article: http://technolog.msnbc.msn.com/_news/2010/12/16/5660488-facebooks-facial-recognition-knows-who-your-friends-are-