If he's only four months old and doesn't jump on furniture, he probably inherited his bad knees. Did your breeder give you a guarantee on genetic defects? I'd definitely call her and let her know what your vet said because knee surgery, if he needs it, runs into the thousands. Your breeder will also want to know about his problem if she is reputable so she can stop breeding his parents.
Did you vet grade his knees? Luxations are graded from 1-4 with 4 being the worst. Threes and fours always need surgery.
I'd suggest if your vet thought his knees were so bad that you get a recommendation from her to an orthopedic vet for a second opinion.
Here's more information for you.
http://www.yorkshire-terrier.com/lacy/medical.htm