Benjy Sarlin June 2, 2011, 5:07 PM

Moody’s Investment Service will likely downgrade America’s credit rating if Congress can’t reach agreement on a debt ceiling increase by mid-July, the firm said in a statement Thursday.

The major credit rating firm warned that political bickering has gotten out of hand and that they were concerned the two parties’ may not reach a deal before the country defaulted on its obligations, which the Treasury Department warns will occur in early August, setting off a financial crisis.

“Although Moody’s fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations,” the statement read. “The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody’s will place the rating under review.”

The Moody’s statement comes after reports yesterday that the White House’s meeting with House Republicans produced little progress in bridging their differences.

“Since the risk of continuing stalemate has grown, if progress in negotiations is not evident by the middle of July, such a rating action is likely,” Moody’s said.

Democratic leaders have argued for a “clean” debt limit vote that includes no spending cuts or other attachments in order to assure the market that America’s credit is sound. The strongly worded statement gives them some added ammunition against top Republicans who are openly questioning whether a short term default would even harm the economy.

“This simply underscores the need for Congress to move quickly to ensure that the US can meet all of its obligations, while continuing to work on a consensus approach towards long term fiscal balance,” Mary Miller, Assistant Secretary for Financial Markets at the Treasury Department, told TPM in a statement.

After a meeting at the White House Thursday afternoon during which the Moody’s statement was released, Minority Leader Nancy Pelosi (D-CA) told reporters that she was surprised by the Moody’s announcement after receiving assurances from the firm’s executives recently that they would not downgrade U.S. debt. She said the latest Moody’s statement did not come up in the meeting today between House Democrats and President Obama.

Both Pelosi and Minority Whip Steny Hoyer (D-MD) warned a default would be serious, but expressed confidence a deal would be struck before such an event occurred.

“If we default, it would cause a real mess in the mortgage industry,” Pelosi said. “We’re not going to default. The fiscal soundness of our country is important to economic growth.”

While the urgency of the firm’s message lends weight to Democrats’ arguments that Republicans are playing with fire, Moody’s also said that they had previously rated U.S. bonds as stable in part because they expected the debt vote to produce a long-term deal to get the deficit under control. Republicans have demanded trillions of dollars in unspecified cuts in exchange for their votes and Speaker John Boehner cited the Moody’s statement as evidence the market was on their side.

“This report reinforces the point Republicans have been making all year: an increase in the debt limit without major spending cuts will hurt our economy and destroy jobs,” Boehner said in a statement. “As I said just yesterday, the deficit talks led by Vice President Biden are making progress, and Eric Cantor is doing an excellent job representing us in those talks, but the White House needs to step up.”

A spokesmen for Minority Leader Mitch McConnell (R-KY), Don Stewart, also cited the report as proof a major deficit deal was needed.

“It appears that what Moody’s is saying is that if no ‘significant’ action is taken to reduce the deficit, two bad things will happen: they could lower the rating, and they don’t think anything will be done about the deficit crisis until after the next election,” he told TPM in an e-mail. “Both are unacceptable—and completely avoidable.”

Sen. Chuck Schumer (D-NY) said in a statement that Republicans needed to cut back on their demands in order to break the impasse.

“A compromise that both prevents a catastrophic default on our obligations and significantly reduces the debt is within reach, but only if Republicans stop insisting on unattainable, ideological goals like their extreme plan to dismantle Medicare,” he said.

Susan Crabtree contributed reporting to this post.

Debt Ceiling, Harry Reid, John Boehner, Mitch McConnell, Nancy Pelosi, Steny Hoyer