Maternal diabetes during pregnancy is responsible for the occurrence of diabetic embryopathy, a spectrum of birth defects that includes heart abnormalities, neural tube defects, and caudal dysgenesis syndromes. Here, we report that mice transgenic for the homeodomain transcription factor Isl-1 develop profound caudal growth defects that resemble human sacral/caudal agenesis. Isl-1 is normally expressed in the pancreas and is required for pancreas development and endocrine cell differentiation. Aberrant regulation of this pancreatic transcription factor causes increased mesodermal cell death, and the severity of defects is dependent on transgene dosage. Together with the finding that mutation of the pancreatic transcription factor HLXB9 causes sacral agenesis, our results implicate pancreatic transcription factors in the pathogenesis of birth defects associated with diabetes.