Pete's right. Vito and Tom knew right away that Carlo had set up Sonny. It's been speculated here that Vito simply couldn't bring himself to have his daughter's husband killed, especially in the state of grief and shock he was in because of Sonny's death. Also, as Vito states in the novel, "Revenge is a dish best served cold." Vito and Michael were jollying Carlo along until the time was ripe--after Vito died and on the day when Michael "settled all family business."

Carlo exemplifies how greed and lust for revenge blind people--a regular theme in both the novel and the movie. How the hell could Carlo think he could get away with anything so obvious as that setup?