Mesenchymal lineage cells arise from pluripotent stem cells in the bone marrow (BM) and transition through a series of developmental stages resulting in mature functional cells. This specification results in the development of osteoblast, adipocytes, myoblasts, chondroblasts, and stromal cells (part of the recticular network). The osteoblast developmental pathway is well understood particularly at the later stages of development. However, less is known about the very early stages, where cell fate decisions that lead to commitment to the osteoblast lineage occur. Adipocytes, the cells that produce fat, likely share a common early progenitor with osteoblasts, although little is known about the molecular control of this lineage bifurcation. Growing evidence indicates that transcription factors required for B lymphocyte development from hematopoietic stem cells are critical for proper skeletal development although as yet none have been implicated in osteoblast differentiation. We have discovered that O/E-1, a transcription factor essential for B cell development, is expressed in osteoblasts and plays a critical role in controlling osteoblast development. O/E-1-deficient mice are runted, have increased bone formation parameters, and have a striking increase in osteoblasts. Remarkably, these mice also exhibit a dramatic expansion of adipocytes in the medullary canal of long bones.