Hi,
Apologies for replying late, this thread wasn't ignored.. I've been reading several forums & have also asked the Joomla Devs to take a look into this. The problem you are facing with the Joomla's FTP Layer feature is a BUG within the specific release [1.5.2].. It seems that you have a
VPS Hosting plan with us,
you can downgrade/reinstall the Joomla application to 1.0.x & it'd work fine... 
Also, regarding your question,
the FTP Layer feature is nothing special, but it just allows file operations (such as installing Extensions or updating the main configuration file) without having to make all the folders and files writable. This has been an issue on Linux and other Unix based platforms in respect of file permissions. This makes the web site hosting admin's life a lot easier and increases security of the site..
You can check the write status of relevant folders by going to "
Help->System Info" and then in the sub-menu to
"Directory Permissions".
With the FTP Layer enabled even if all directories are red, Joomla! will operate smoothly. NOTE: the FTP layer is not required on a Windows host/server. 