The Salvation Army and Oxfam do recycle textiles, selling on unwearable clothes or fabrics as raw materials. They can be shredded and used as insulation materials, in roofing felts, padding, or used as cloths in a range of industries. Wool can be reclaimed and made into yarn by specialists. TRAID takes torn or stained clothing and remakes into one-off garments which are then sold under the TRAIDremade label.
Boujad rug from Flickr/Luciano Ghersi
Taking TRAID's initiative a step further are women in Morocco who are using pieces of material from old clothes to creating rugs in the Essaouira tradition. They use a hook to knot the pieces of fabric on to a canvas backing and let their imaginations create beautiful ethnic-style rugs in geometric designs. Développement Durable has some good pictures of the colourful end product.
There are other ways to make rag rugs - braiding, crochet - but I'm no crafty expert. I will not be making us a rug out of the odd sock mountain, but I'll be giving them to Oxfam rather than to landfill.