The most common genetic cause of amyotrophic lateral sclerosis (ALS) and frontotemporal dementia (FTD) is the expansion of a hexanucleotide repeat in a non-coding region of the gene C9orf72. We report that loss-of-function mutations in alfa-1, the Caenorhabditis elegans ortholog of C9orf72, cause a novel phenotypic defect: endocytosed yolk is abnormally released into the extra-embryonic space, resulting in refractile "blobs." The alfa-1 blob phenotype is partially rescued by the expression of the human C9orf72 protein, demonstrating that C9orf72 and alfa-1 function similarly. We show that alfa-1 and R144.5, which we identified from a genetic screen for mutants with the blob phenotype and renamed smcr-8, act in the degradation of endolysosomal content and subsequent lysosome reformation. The alfa-1 abnormality in lysosomal reformation results in a general dysregulation in lysosomal homeostasis, leading to defective degradation of phagosomal and autophagosomal contents. We suggest that, like alfa-1, C9orf72 functions in the degradation of endocytosed material and in the maintenance of lysosomal homeostasis. This previously undescribed function of C9orf72 explains a variety of disparate observations concerning the effects of mutations in C9orf72 and its homologs, including the abnormal accumulation of lysosomes and defective fusion of lysosomes to phagosomes. We suggest that aspects of the pathogenic and clinical features of ALS/FTD caused by C9orf72 mutations, such as altered immune responses, aggregation of autophagy targets, and excessive neuronal excitation, result from a reduction in C9orf72 gene function and consequent abnormalities in lysosomal degradation.