The expansion valve controls the flow of liquid freon into the evaporator. In some systems this is the only freeze-up control, with the valve completely closed at 33F. while in others it never completely closes and there is a thermostat somewhere that shuts the compressor off.
It is open wider at higher temps, so that the air coming out is a contant temp. Also, it will never allow enough freon through to get liquid going into the compressor.
The CCOT type designs flood the evaporator, with an accumlator on the low pressure side to trap the liquid freon (and the compressor will tolerate small amounts of liquid, too), with a pressure sensor on the accumulator to prevent freeze-up.
Not too hard to change the expansion valve on the W124, on the W126 it's under the dash, more of a PITA.
I would be shocked if that capillary contains mercury -- I'd guess a viscous silicone fluid of some sort. Mercury would corrode out of any copper containg metal pretty fast (and eats most others, too, on top of being toxic).
1972 220D ?? miles
1988 300E 200,012
1987 300D Turbo killed 9/25/07, 275,000 miles
1985 Volvo 740 GLE Turobodiesel 218,000
1972 280 SE 4.5 165, 000 - It runs!