Just as it does on the Web, Picasa scans your photos for faces, then groups together photos of specific people. It's then your job to tell it who they are as well as confirm its guesses. If someone you're tagging is in your Google address book, you can also look them up very quickly with auto-complete. Otherwise, Google gives you the option to add them as someone new; this information then gets synced back up your Google address book.
The system worked very well for me, but it was slow going. I had to leave the program running overnight for it to finish processing my 3,700 or so photos for faces. It also had my processor humming, since it was doing all the work on my machine instead of Google's giant server farm.
That's not to say Google hasn't included a few things to help speed up the process. For one, if you've got photos that are both hosted online and on your hard drive--and that have already been scanned for faces, the Picasa software can grab that information and add it to your local library. This saves it from having to scan the same photos twice.
And for photos it thinks contain people you've verified as contacts, it gives you quick "yes" and "no" buttons that can add or reject name tags. Oftentimes, clicking "yes" adds a few more suggestions for photos of that person that the program feels is safe enough to recommend. There's also a way to group accept or group decline its suggestions, which saves time you would have otherwise spent clicking the buttons one at a time.
As with Picasa Web Albums, your reward for trudging through your photos to add tags is better organization, which for a massive library of old, archived shots can be hugely helpful. And unlike Picasa's albums feature, name tags let you quickly sort all of your photos by who's in them--not when they were taken or how you've personally organized them. It also continues to do this with any photos you add to your library in the future.
Along with facial recognition, the new version of the software integrates Google Maps--a much-wanted feature among geotagging fans. Just as you're able to do in Picasa Web Albums, you can search for a location in Google Maps, then amend that geographic data to your photo. You can also view groups of photos by place by clicking on little red map markers that show where individual photos have been placed. Unlike the facial recognition feature though, this is still largely a manual process of doing a search for each location then adding it to a photo, or group of photos, at once. That is, unless you have a camera with GPS (which most people don't).
One big thing Google is bringing to the table with this release over something like Apple's iPhoto (at least for Mac users) is the capability to tag items that are spread out across your entire computer, as well as external drives. In that regard, it does a much better job than iPhoto when it comes to automatically importing and organizing photos--all without disturbing where they're stored. Considering it now does much of what iPhoto is able to do with faces, with the added bonus of grabbing that contact information from your Google address book, it makes for a very seamless experience.
The new version of the software should appear as an update for users of Picasa v3.1 the next time they start the program. It can also be forced to update by clicking the "check for updates online" option in the help menu.