The term comes from the hammer action on a gun. The hammer dropping on many pistols is what causes them to fire. If you "drop the hammer" on somebody, you go all out.
The expression can be used in several different variations with the above definition: 1) ...part. in a draconian way 2) ...leaving a wake of destruction in its path 3) ...against a very specific target with precision; etc.
"You have the green light. Drop the hammer on that motherfucker."
BANG. Bad guy fall down.
When someone raises early (usually pre-flop if playing Holdem) just to push other players around, and you just can't take that smug grin on his face, you re-raise a ridiculous amount and "drop the hammer." This most often occurs during a Testosterone Fight, and the object is to make the other player put his testosterone hose away and fold. Since it is pre-flop, this has nothing to do with the cards you have, just plain good ol' fashioned balls.
Ryan: I call.
Mike: I call.
Kevin: I call.
Marco: I call.
Matt: I call.
Dana: I call.
Devin: I call.
Dave: Well... I'll just double the blinds so I have even stacks... mwaahaahahaa...
Devin: Fuck that! I'm DROPPING THE HAMMER! All in, bitch!
Sam: Coooold bloooooded.....