I don't think the democrats are completely fear mongering. If the debt ceiling is not raised, the consequences will not be pleasant for some time. There are logical steps that will take place and the results will be a mix between the propaganda of the 2 parties. Republicans would get a predicted balanced budget and fiscally responsible government. Democrats would get the predicted financial crisis. If the ceiling is not raised:
(1) The federal budget will IMMEDIATELY be balanced, literally, in an instant. The limit to borrowing will ensure that the government cannot spend more than it takes in in tax revenues. This may sound good, but there are further consequences of balancing a budget in this manner.
(2) Credit across markets will collapse resulting in a sharp drop in the money supply. A major source of lending and borrowing would instantly be eliminated which would collapse credit and the money supply in an instant.
(3) GDP would contract as a large part of that figure is government spending. This is to say there would indeed be another recession - it's simple first grade math.
(4) As credit collapses and the money supply contracts sharply, prices will begin falling and we will quickly be in a deflationary/depressionary environment.
(5) A collapse of credit, the money supply, prices and GDP will give business earning across the economy a serious hit. This will be anticipated on August the 3rd with a large drop across markets including big items like stocks, commodities, housing, etc..
(6) A deflationary environment leads to drops in prices for everything - including your wages. People with large amounts of debt will quickly be in trouble as debt remains fixed while prices across the economy fall (or rise). This will be a further hit to markets and would likely intensify the governments debt problems in addition to hurting those across the economy who are in debt (think of cars, houses, credit cards, student loans, etc).
(7) The hit to businesses will cause businesses to begin economizing - meaning higher unemployment.
(8) I'm undecided what will happen to interest rates, bonds, and the US Dollar. Much of it depends on who the Treasury and Administration decide to pay and how the credit rating agencies respond. If creditors are assured of payment, bonds may rise, which keeps interest rates low. But since it's the credit rating on the line, it could easily be that bond markets get rocked and interest rates shoot up (think of Italy, Greece, Portugal, Ireland, etc..). If bonds rise, the dollar will likely rise, but again since it's the credit rating on the line, there's a good chance that the dollar will crumble relative to other currencies. This would all be moot if the credit agencies reduce the rating all the way to "default" status. In this case we may be talking bank run and currency crisis. There would also be a big payday for Credit Default Swaps (remember those little devils from a couple of years ago?).
Those who think that nothing will happen if the debt ceiling is not raised are seriously mistaken. Credit and money supply collapse, GDP contraction, and deflation, are assured by simple math. The ancicipation of the hit to business earnings/profits is certain to be displayed across markets as they begin to contract (bye bye stock market). A bank run becomes a serious danger as the "safe" asset of the US bond stands to turn into a liability, literally overnight.
My prediction, beyond the easy consequences to spot, is that this will all not last long though. Politicians will not be able to stomach the results. And if they do not intervene with a deal, the Federal Reserve has a stated policy against severe deflation, and just stated last week that QE3 is not off the table. If Congress did not act, the Fed would step in with QE3 in an attempt to save the economy. Who knows what the results of that would be.
My actual prediction is that congress members are well aware of these consequences and a deal will be reached before to raise the debt ceiling. But, it did take a stock market crash to get them to vote a second time in favor of TARP in '08.