I see that when printing out a label we have the option to choose return to paperback swap if undeliverable.  What happens to all these books, as they are not returned to the original sender?

They have a transaction number on them, next to the return address.  PBS can trace which book and address from that number.  Don't know what they do.  But they can figure out the from and the to.

I don't think they return them to the sender if they get sent to them for anyreason. They just don't have the budget to do that.  They probably get donated somewhere. 

It happened to me once - they remailed the book to the requestor and charged me a credit for the postage. I was pleased -- and surprised, since I'd handwritten the address and there was no transaction number!