ssh-keygen does not lie, i create passwordless keys all the time with it.
Also, revert your changes in sshd_config as this has nothing to do with it and 
makes your ssh server insecure.

Have you done the "Saving Keys on Remote Computers" part in
https://help.ubuntu.com/community/SSH/OpenSSH/Keys ?

If yes, please post the output of ssh -v HOST .

** Changed in: openssh (Ubuntu)
       Status: New => Incomplete

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SSH uses login password even when empty password was specified in ssh-keygen
https://bugs.launchpad.net/bugs/511668
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