Luther: As soon as our Gospel began, decency and modesty were done away with, and everybody wished to be perfectly free to do whatever he liked

Here's a Luther quote from the book, Calvin the Psychopath:

Other Testimonies as to the Effects of the Reformation:

Luther: "As soon as our Gospel began, decency and modesty were done away with, and everybody wished to be perfectly free to do whatever he liked." 

Documentation
This quote pops up every once in a while, typically used by Rome's defenders as proof of the failure of the Reformation, Luther's regrets or concession to the failure of the Reformation, etc. (example #1, example #2, example #3, example #4).

Calvin the Psychopath appears to be using this Roman Catholic source from 1901. This 1901 source probably relied another Roman Catholic source: Henry O'Connor, Luther's Own Statements Concerning His Teaching and Its Results: Taken Exclusively from the Earliest and Best Editions of Luther's German and Latin Works (1884), p. 55. O'Connor states, "Luther says: 'As soon as our Gospel began....... decency...... and modesty were done away with, and everybody wished to be perfectly free to do whatever he liked' (Walch. V. 114)." It appears to me that most (if not all) of the English translations stem from this source. The translation into English was probably done by O'Connor.

Luther's Own Statements Concerning His Teaching and Its Results is an old small anthology of Luther quotes peppered with vilifying commentary from O’Connor. The author claims to have compiled the quotes from the original sources: “Nearly two-thirds of the matter contained in this pamphlet is taken from the original editions of Luther’s own Works, as published in Wittenberg, under the very eye of the Reformer of Germany himself”(p. 3) He says “I have taken special care not to quote anything, that would have a different meaning, if read with the full context”(p.5).

The footnote "Walch V" refers to the fifth volume in a set of Luther's works published between 1740-1753 by Johann Georg Walch. Page 114 can be found here (see second column, note "V 112-115" on the top right). The German text states:

This paragraph is from Luther's comments on Psalm 2:1 (March 1532). Technically, Luther did not write this text. These printed words are from the notes of Georg Rörer who heard Luther's lecture (and there is a possibility Veit Dietrich's notes were used as well, see LW 12:viii).   A Latin version can be found in WA 40 II:198-199. There is an English translation in LW 12:7-8 (cited below).

Context
Luther's comments refer specifically to the Psalmists words, "Why do the nations conspire and the peoples plot in vain?" Note the words in bold quoted by O'Connor and also the surrounding context from Luther.

This is a very moving introduction and a wonderfully apt rhetorical figure. For the prophet is filled with amazement and asks: “What is this, anyway? The nations conspire, and the peoples plot and take counsel not against the king of the Persians, not against the Turk, but against the Lord. Will these efforts not prove to be ridiculous, stupid, and foolish? Let no one therefore fear, let no one allow himself to be terrified by these counsels, whose net result will show that they have been in vain. For they are undertaken not against man, as it seems, but against the Lord.” Thus right in the beginning he leads us from fear to hope and offers the comfort that the peoples and the nations will perish unless they abandon these counsels, because they plot against God and not against men.

Read the writings of the papists, listen to their discourses, and you will find that they rely on this one argument, namely, the claim that nothing good has come of our teaching. For immediately after our Gospel sounded forth, there followed the horrible revolt of the peasants, disagreements and sects arose in the church, discipline broke down, and, as if all the restraints of the laws were done away with, all began to indulge in the greatest license. This is indeed true. For now there is greater freedom for all vices than there was in former times, when the common crowd was coerced with fear. But now, like an unbridled horse, it undertakes everything according to its own good pleasure. For it despises the ecclesiastical chains with which it was formerly held by the papacy and makes full use of the negligence of the civil magistrate. All these misfortunes, which are by no means trifling, our adversaries impute to our teaching or to the Gospel.

But suspend judgment a little while, and first reflect more carefully. Reduce the argument to a dialectical form, and consider whether this is a logical conclusion: “This theologian is evil, therefore theology is evil; this lawyer is worthless, therefore a knowledge of the law is also bad; this teacher is a fornicator, therefore the arts which he teaches are a fornication.” Would we not call anyone mad who defended these conclusions as good and sound? Nevertheless the adversaries draw inferences not a bit wiser than this. But listen to this psalm foretelling that when this King begins His kingdom, that is, when He begins to teach, the murmurings of the heathen will follow, the conspiring of the peoples, battles and the wars of kings, the plottings and counsels of the rulers. Against whom? Against the Lord and His Christ. Therefore fortify your conscience and, admonished by the Holy Spirit in this passage, understand that the world will be in an uproar. But do not put the blame on this King or His Word, but rather on Satan and the godless world. You must, on the contrary, affirm and declare: “Though evils follow the teaching of this King, nevertheless the teaching is not on that account evil, but rather the men are evil who are opposed to the good teaching and wish it suppressed.” For it is a true and logical conclusion that the more eagerly the world opposes this sacred teaching, the more evil and wicked it is. Nor should the teaching be maligned on account of the fault of men. The Jews crucify Christ, shall we therefore accuse Christ, the Teacher? It is therefore necessary for us to be well fortified in advance and to say: “What is that to God, what is that to His Word, if men are evil? For this is the imperfection of men, not of God, who for this very reason sends His Son and His Word that men may be saved. But if they are not willing, they perish by their own fault. Christ does not for this reason cease to be the Son of God, God does not for this cause reject Him whom He has appointed king over all things.” [LW 12:7-9].

Conclusion
When O'Connor used this quote it was part of a montage of Luther statements explaining the "Moral Results" of Luther and the Reformation (p.50).  O'Connor states,

Every reasonable person will agree with me, that Luther can only have been a Reformer chosen by Almighty God, if his teaching caused an increase of virtue and a decrease of vice. If, however, it can be plainly shown, that in consequence of his teaching there was, on the contrary, an increase of vice and a decrease of virtue, we must come to the conclusion, that Luther had not the sanction of God for the work which he undertook (p.50).

Ironically, both O'Connor and Luther appeal to reason to explain the state of things in sixteenth century Germany. O'Connor's paradigm appears to be almost postmillennial: God authorizes particular people to straighten the church out and get it back on track. Luther's paradigm is that there is a higher standard of truth that must be upheld even if it causes trouble. Mankind will always oppose God's truth en masse and rebel against it, for that's what Satan and sin have always done in battle against God's word. Luther consistently held that the Gospel would find great opposition, and would be attacked from all sides. The Gospel would be used by the world as a licence to sin and all sorts of evil because of Satan. The Gospel would indeed make those of the world worse. But on the flip-side, the Gospel would also transform those whom God intended to redeem, and they are those who comprise the church.


Addendum
 Also in Henry O'Connor, Luther's Own Statements Concerning His Teaching and Its Results: Taken Exclusively from the Earliest and Best Editions of Luther's German and Latin Works (1884), p. 55, another quote from this same context is provided:

"In all classes frivolity and every kind of vice, sin, and disgrace are now much greater than formerly" (Walch. V. 114)."

This appears to be the following text from LW 12:

For now there is greater freedom for all vices than there was in former times, when the common crowd was coerced with fear. But now, like an unbridled horse, it undertakes everything according to its own good pleasure. For it despises the ecclesiastical chains with which it was formerly held by the papacy and makes full use of the negligence of the civil magistrate. All these misfortunes, which are by no means trifling, our adversaries impute to our teaching or to the Gospel. [LW 12:7-8]