Mutations in fibroblast growth factor (FGF) receptors are responsible for a variety of skeletal birth defects, but the underlying mechanisms responsible remain unclear. Using a mouse model of thanatophoric dysplasia type II in which FGFR3(K650E) expression was directed to the appendicular skeleton, we show that the mutant receptor caused a block in chondrocyte differentiation specifically at the prehypertrophic stage. The differentiation block led to a severe reduction in hypertrophic chondrocytes that normally produce vascular endothelial growth factor, which in turn was associated with poor vascularization of primary ossification centers and disrupted endochondral ossification. We show that the differentiation block and defects in joint formation are associated with persistent expression of the chondrogenic factor Sox9 and down-regulation of β-catenin levels and activity in growth plate chondrocytes. Consistent with these in vivo results, FGFR3(K650E) expression was found to increase Sox9 and decrease β-catenin levels and transcriptional activity in cultured mesenchymal cells. Coexpression of Fgfr3(K650E) and Sox9 in cells resulted in very high levels of Sox9 and cooperative suppression of β-catenin-dependent transcription. Fgfr3(K650E) had opposing effects on Sox9 and β-catenin protein stability with it promoting Sox9 stabilization and β-catenin degradation. Since both Sox9 overexpression and β-catenin deletion independently blocks hypertrophic differentiation of chondrocytes and cause chondrodysplasias similar to those caused by mutations in FGFR3, our results suggest that dysregulation of Sox9 and β-catenin levels and activity in growth plate chondrocytes is an important underlying mechanism in skeletal diseases caused by mutations in FGFR3.