When you switch on the power using the main switch on the front panel, power is provided to the front panel neon, which lights provided the thermal fuse in the neutral wire is intact.
Power is also provided to the elements, via the coffee thermostat and the steam thermostat. If either of these has dirty contacts, then they may not provide power to the element, and so it will not heat the water. You may notice the water not heating quickly as the thermostat contacts dirty and create resistance to the current reaching the element. This will only get worse until the thermostats ultimately fail.
When the water in the boiler has reached 95degC, the coffee thermostat will open (4 in the diagram above). The current which was heating the element will now take the alternative route through the neon (11), which has a high resistance, and although in series with the element, will not allow it to continue to heat the water.
Of course if the boiler cools down, the coffee thermostat will close and the cycle will continue. If the coffee thermostat is faulty and the contacts have welded themselves together, then the coffee thermostat will remain closed and heating will continue until the steam thermostat (5) opens and the neon comes on. When a coffee shot is subsequently drawn, steam will come out, rather than hot water.
The coffee switch (9) is closed to pull a shot. This provides power to the pump (10) and the 3-way solenoid (8). The three way solenoid routes the coffee from the boiler to the coffee (it normally sits idle and routes the coffee water to the drain, to release pressure from the puck).
To heat the water to make steam, the steam switch (7) is closed.
This shorts across the 95degC thermostat and so the steam thermostat (5) now controls the boiler temperature.
It also opens the power feed to the solenoid (8), in case the coffee switch has accidentally been left closed, or the coffee switch is operated (otherwise steam would issue from the group head).
When the seam in the boiler is up to temperature (145degC) the steam thermostat (5) opens, and the neon (11) lights again. You can now steam milk.